F8: AUDIT AND ASSURANCE SIR AHMED SHAFI RPORA’ GOVERNANCE AUDIT COMMITTEE: ‘Subcommittee of board usually comprising NED’s but independent NED’s. {ESPONSIBILITI A F AUDIT 1. Monitors integrity of financial statements and any formal announcements relating to company’s financial performance. 2. Reviews company’s financial controls unless separate risk management, committee Is looking after it. 3. Monitors and reviews internal audit function of the company. 4. Provide recommendations to board regarding external auditors Ie. appointment, reappointment, remuneration, removal, etc. 5. Monitors and reviews independence and objectivity and eventually effectiveness of audit process. 6. Also carries out investigation for fraud and error. 7. Available to external auditors for any unresolved issues. ADVANTAGES OF AUDIT COMMITTEE: * Provides assurance to shareholders regarding external audit process. ‘* Strengthens public confidence in the company (double check) Provides NED's an opportunity to play a vital role in corporate governance. '* Helps internal audit function to work with independence and objectivity (as no pressure are involved) «Helps create a climate of discipline which reduces chances of fraud and error. DISADVANTAGES OF AUDIT COMMITTEE: NED’s have insufficient time as they are involved with many companies so may lead to poor DM. ED’s may not understand purpose of audit committee, may think its supervision on them. Costs of audit committee may outweigh benefits. NED's with caliber and skill may be difficult to select and retain, Such formal procedures may hinder smooth flow of operations. Best practices of good corporate governance/Actions that B.0.D should take to meet corporate governance requirements for listing Balance between ED’s and NED’s on Board Audit committee established by independent NED’s Presence of nomination, remuneration and risk management committees Effective audit committee CEO and chairman should be different Accountability of 8.0.0 to shareholders 1|Page Scanned with CamScannerF8: AUDIT AND ASSURANCE ‘SIR AHMED SHAFI Transparency in reporting Company's carrying out CSR Good coordination between ED's and NED's Not paying excessive remuneration Remunerations of EDs (CEO, CFO etc) to be determined by remuneration committee ‘Audit committee only has NED'S Internal audit department reports to audit committee Timely rotation of directors (every three years) Directors to be appointed at regular intervals through election ensuring accountability Internal audit department Regularly holding AGM Giving induction training to staff NED’s should not be previously ED’s ‘At least one member of audit committee having relevant financial experience Chairman CEO Head of Board Head of Company Part Time Full Time Elected by the shareholder vote Elected by Directors ED (involved in company matters) Role of Chairman Role of CEO Running the Board Strategy making Encouraging involvement of all directors Investing and Financing ‘Appraisal of Board Risk management Reporting and Signing accounts Board Committee Information availability for the board Establishing management Effective communication with shareholders Liason with shareholders Dealing with issues Note: CEO and CHAIRMAN should be different because accountability will be done by the same person who is accountable (bekaar baat) Board must have a balance of ED’s and NED’s because people doing the work will be monitoring the ‘work leading to accountability problem (ek aur bekar baat) IMPORTANT POINT ABOUT BOARD: Board members are called directors (BOD) ‘There are two types of members/directors 2|Page Scanned with CamScannerbased exam, but this question provides valuable practice for all students whichever version of the exam they are toking . Paramore Co has recently approached your firm to request an audit. This Is the first year they have met the size threshold for audit requirement. ‘The directors are unsure of the audit process and regulations governing an audit and have asked for some Information. The following questions have been emalled to you by the directors of Paramot . . (0) Howcan we be sure the audit will be performed to a satisfactory standard of quality? . (i) Will the audit identify every fraud and error within Paramore? (ili) Do you have any rights as auditors that we need to be aware of? 31 In relation to question (I), which THREE of the following responses should be communicated to the directors of Paramore? Yes | _No The audit will be performed In accordance with - | International Standards on Auditing [Internationat Standards on Auditing are legal requirements The firm will implement quality contral procedures (poem —— : esi (2 marks) 32 In relation to question (Il), which TWO of the following responses should be communleated to the directors of Paramore? ; ‘ . Yes No | [The audit will find every fraud and error ‘The audit may find fraud and error in the items tested it Is not the auditor’s main objective to Identify every fraud and error The audit will not test every transaction therefore some . fraud and error may go undetected. (2 marks) 33. Inrespect of question (Il), which of the following are auditor rights? Yes No ‘Allow the auditor to attend management meetings Provide the auditor access to all books and records ‘Allow the auditor to speak at the general meetings . Provide the auditor with notice of general mectings (2marks) Scanned with CamScanner hel sto Guest bea] a aa pa ee This objective test case question contains question types which will only oppear,In'a computer 534 For each of the following, state whether they are benefits or limitations af having an audit, : : : — Benefit Umitation An audit may highlight deficiencies In Internal controls Which will be communicated to Management * ta An audit provides Management with assurance that they have prepared their financlal statements In accordance with _ ‘ the appropriate financlal reporting framework Sampling will be used to obtain audit evidence | Evidence Is persuasive rather than conclusive l (2 marks) 35 Which of the following statements Is NOT true In relation to who may act as auditor? A Anauditor must be a member of a recognised supervisory body B Adirector or employee of the company cannot act as auditor € An auditor must have ten years’ Post qualification experience before belng allowed to Sign an auditor's report ” D Auditors must consider If there are any ethlcal reasons that Would prohibit them acting as afiditor to a company . , (2 marks) Scanned with CamScannerF8: AUDIT AND ASSURANCE SIR AHMED SHAFI ED's (Executive Directors) ; Full time employees, head of key functions like finance, purchasing, production, etc are given a seat in board, have a dual role (involved in company as well as board) NED’s (Non-Exect Directors) : are outsiders with no dual role , are not full time employees, no managerial involvement, just come and attend board meeting. ED's and NED’s both take money for service, one is full time one is part time. 10 JUMPER (AIR 6/06) (AMENDED) You are the audit manager of Tela &Co., a medium-sized firm of accountants. Your firm has just been asked for assistance from Jumper & Co., a firm of accountant in adjacent country. This country has just introduced a requirement for entities to conform to the internationally recognized codes on corporate governance and Jumper & Co. has number of clients where the codes are not being followed. One example of this, from SGC, a listed company is shown below. As your country has already appropriate corporate governance codes in place, Jumper & Co. have asked for your advice regarding he changes necessary in SGCC to achieve appropriate compliance with corporate governance codes. Extract from fi statements regarding corporate governance Mr. Sheppard is the Chief Executive Officer and board chairman of SGCC. He appoints and maintains a board of five executive and two non-executive directors. While the board sets performance targets for the senior-managers in the company, no formal targets are set and no review of board policies is carried out. Board salaries are therefore set and paid by Mr. Sheppard based on his assessment of all the board members, including him, and not their actual performance Internal controls in the company are monitored by the senior accountant, although detailed review is assumed to be carried out by the external auditors; SGC does not have an internal audit department. Annual financial statements are produced, providing detailed information on past performance. Required Describe five corporate governance weaknesses faced by SGCC and provide recommendations to address each weakness, to ensure compliance with corporate governance principles. 11 CONOY (6/03) (AMENDED) Conoy Co designs and manufactures luxury motor vehicles. The company employs 2,500 staff and consistently makes a net profit of between 10% and 15% of sales. Conoy Co is not listed. Its shares are held by 15 individuals, most of them from the same family. The maximum shareholding is 15% of the share capital. The executive directors are drawn mainly from the shareholders. There are no non-executive directors because the company legislation in Conoy Co's jurisdiction does not require any. The executive directors are very successful in running Conoy Co, partly from their training in production and management techniques, and partly from their ‘hands-on’ approach providing motivation to employees. The board is considering the significant expansion of the company. However, the company’s bankers are concerned with the standard of financial reporting as the financial director (FD) has recently left Conoy Company. The board are delaying provision of additional financial information until a new FD is appointed. 3|Page Scanned with CamScannerF8: AUDIT AND ASSURANCE SIR AHMED SHAFI Conoy Co does not have an internal audit department, although the chief internal auditor frequently Comments that the board of Conoy Co does not understand his reports or provide sufficient support for his department or the internal control systems within the Conoy Company. The board of Conoy Co concur with this view. Anders and Co, the external auditors have also expressed concern in the area and the fact that the internal audit department focuses work on control systems, not financial reporting. ‘Anders and Company are appointed by and report to the board of Conoy Co. The board of Conoy Co are Considering a proposal from the chief internal auditor to establish an audit committee. The committee would consist of one executive director, the chief internal auditor as well as three new appointees, One appointee would have a non-executive seat on the board of directors. Required Describe five roles of the audit committee and explain how Conoy Co would benefit from each of these roles. 118 SERENA (12/11) (AMENDED) Serena VOW has been trading over 20 years and obtained a listing on a stock exchange five years ago. It provides specialist training in accounting and finance. The listing rules of the stock exchange require compliance with corporate governance principles and the directors are fairly confident that they are following best practice in relation to this. However, they have. recently received an email from a significant shareholder, who is concerned that Serena VDW Co does ‘ot comply with corporate governance principles. Serena VOW Co's board is comprised of six directors; there are four executives who originally set up the company and two non-executive directors who joined Serena VOW Co just prior to the listing. Each director has a specific area of responsibility and only the finance director reviews and financial statements and budgets. The chief executive officer, Daniel Brown, set up the audit committee and he sits on this sub-committee along with the finance director and the non-executive directors. As the board is relatively small, and to save the costs, no internal audit function has been set up to monitor internal controls. ‘The executive director's remuneration is proposed by the finance director and approved by the chairman. They are paid an annual salary as well as a generous annual revenue related bonus. Since the company listed, the directors have remained unchanged and none have been subject to re- election by shareholders. Required: Describe five corporate governance weaknesses faced by Serena VDW Co and provide recommendations to address each weakness, to ensure compliance with corporate governance principles. 4|Page Scanned with CamScannerF8: AUDIT AND ASSURANCE ‘SIR AHMED SHAFI Saxophone Enterprise Co. Saxophone Enterprises Co (Saxophone) has been trading for 15 years selling insurance and has recently become a listed company. In accordance with corporate governance principles Saxophone maintains a ‘small internal audit department. The directors feel that the team needs to increase in size and specialist skills are required, but they are unsure whether to recruit more internal auditors, or to outsource the whole function to their external auditors, Cello & Co. ‘Saxophone is required to comply with corporate governance principles in order to maintain its listed status; hence the finance director has undertaken a review of whether or not the company complies. Bill Bassoon is the chairman of Saxophone, until last year he was the chief executive. Bills unsure if ‘Saxophone needs more non-executive directors as there are currently three non-executive directors out of the eight board members. He is considering appointing one of his close friends, who is a retired chief executive of a manufacturing company, as a non-executive director. The finance director, Jessie Oboe, decides on the amount of remuneration each director is paid. Currently all remuneration is in the form of an annual bonus based on the profits. Jessie is considering setting up an audit committee, but has not undertaken this task yet as she is very busy. A new sales director was appointed nine months ago. He has yet to undertake his board training as this is normally provided by the chief executive and this role is currently vacant. There are a large number of shareholders and therefore the directors believe that itis impractical and too costly to hold an annual general meeting of shareholders. Instead, the board has suggested sending out the financial statements and any voting resolutions by email; shareholders can then vote on the resolutions via email Required: (a) Explain the advantages and disadvantages for each of Saxophone Enterprises Co and Cello & Co of outsourcing the internal audit department. (b) In respect of the corporate governance of Saxophone Enterprises Co: 1. Identify and explain FIVE corporate governance weaknesses; ji, Provide a recommendation to address each weakness. a4 ETHICS. In order for the public to have confidence in the work performed by professional accountants. Itis essential to have a system of regulation. Regulation can take the form of both ethical and statuary guidance. Required: (a) State the five threats contained within ACCA’s Code of Ethics and Conduct and for each threat list one example of a circumstance that might create that threat. (b) Explain the auditor’s ethical responsibilities with regard to client confident have: i. Anobligatory responsibility ji. Avoluntary responsibility ‘and when they To disclose client information. S|Page Scanned with CamScannerF8: AUDIT AND ASSURANCE SIR AHMED SHAFI 116 STARK (12/08) (AMENDED) You are the manger in the audit firm of Ali and co; and this is your first time you have worked on one of the firm’s established clients , Stark Co. the main activity of Stark Co. is providing investment advice to individuals regarding saving for retirement, purchase of shares and securities and investing in tax efficient savings schemes. Stark is regulated by the relevant financial services authority. You have been asked to start the audit planning for Stark Company by Mr. Son, a partner in Ali & Company. Mr. Son has been the engagement partner for Stark Company for the previous nine years and so has excellent knowledge of the client. Mr. Son has informed you that he would like his daughter Zoe to be part of the audit team this year; Zoe is currently studying for her first fundamentals papers for her ACCA qualification. Mr. Son also informs you that Mr. Far, the audit senior, received investment advice from Stark Co during the year and intends to do the same next year. In an initial meeting with the finance director of Stark Co, you learn that the audit team will not be entertained on Stark Co's yacht this year as this cold appear to be an attempt to influence the opinion of the audit. Instead, he has arranged a balloon flight costing less than one-tenth of the expense of using the yacht and hopes this will be acceptable. The director also states that the fee for taxation services this year should be based on a percentage of tax saved and trusts that your firm will accept a fixed fee for representing Stark Co in a dispute regarding the amount of sales tax payable to the taxation, authorities. Required: (a) Explain the ethical threats which may affect the auditor of Stark Co. (b) For each ethical threat, discuss how the effect of the threat can be mitigated. Ethical threats to independence and objectivity Threat Example SelFinterest * Close business family or personal relationships Undue fee dependency on one client ‘% or contingent fees Low balling to win lucrati Overdue fees Gifts and hospitality Employment with an assurance client Partner on client board Loans and guarantees Financial interests in a client Holding client assets Self-review ‘* Provision of other non-audit services such as tax internal audit validation services corporate finance IT systems services. ‘+ Preparing financial statements and accounting records. + _Recent service with an audit client. ‘Advocacy Promoting shares in a listed audit client other work 6|Page Scanned with CamScannerMirchawala’s Hub of Accountancy: Kingfisher Co: ; following scenario relates to questions 15, . fisher Co{Kingfisher) Is a retail company planning to list on a stock exchange within the next six months, and management has been advised by the company’s auditors about the need for compliance with corporate governance provisions, The finance director has two potential non: ‘executive directors whom he is considering approaching to join the board of Kingfisher. Andrew Finch Is currently an executive sales director of a listed multi-national banking company; he sits or an audit committee of another company as a non-executive director and is agreeable to being paid a fixed fee which is not related to profits. Jack Macaw is currently a finance director of a small ret: company, which does not compete with Kingfisher; he has expressed an interest in a fixed seven year contract and he is the brother of Kingfishers chief executive. Kingfisher is aware that it will need to establish an audit committee to comply with corporate governance best practice. 1. Which committees, other than an audit committee, should Kingfisher with the UK Corporate Governance Code? A. Controls, Remuneration and Nomination committees B. Risk and Financial Reporting committees C._ Nomination and Risk committees D. Nomination and Remuneration committees 2. Once established, which of the following are roles that Kingfishers audit com: (1) Prepare the financial statements to ensure they give a true and fair view. (2} Develop a policy on the engagement and remuneration of external au {3) Implement effective financial reporting internal controls. (4) Monitor and review the effectiveness of the internal audit function. A.Land 2 only B1,2and4 C2and3 D2and4only 3. Which of the follow are advantages of appointing Andrew Finch as a NED of Kingfisher? (2) Andrew is independent of King! {2} Andrews experience in banking will complement the experience of the Kingfisher (3) Andrew is prepared to accept a fixed fee. (4) Andrew is not demanding a fixed term contract, A1,2and3 only B2and4 only: C1,3and4 only DAllof them 4. Which of the follow are advantages of appointing Jack Macaw as a NED of Kingfisher? (1) Jack has close links to Kingfisher’s chief executive (2)ack's experience in retail wil help him understand issues faced by the Kingfisher (3) Jack's financial experience will be useful if he serves on the audit committee (4) Jack wishes to commit to a seven year contract. A1,3and4 only 82 and 3 only €1,2and4 only DAIl of them 5._ Which of the following best describes the aim of corporate governance? ATo ensure companies are well run in the interests of their shareholders and the wider B To ensure company directors cannot commit fraud Cre si the wealth of companies contributes to the health of the economies where their shares D To ensure companies has a positive impact on the local community and environment, lack Af Sir Ahmed Shafi P: Scanned with CamScannerMirchawala’s Hub of Accountanc Cameron Co: Cameron Co has recently become a listed company. Cameron Co is required to comply with corporate governance principles in order to maintain its listed status; hence the finance director has undertaken a review of compliance with corporate governance regulations. Mr Osbourne is the chair 0f Cameron Co ani is also the chief executive. Cameron Co's board of directors comprises six members, two of which are independent non-executive directors. Mr Osbourne is considering appointing one of his close friends as a non-executive director. The remuneration of each director is declared by Mr Osbourne. The company does not have an audit committee 1. Which FOUR of the following statements are benefits to Cameron Co of forming an audit committee? A. The audit committee will provide the shareholders with a channel to communicate with the company on a monthly basis to increase shareholder satisfaction 3. The quality of financial reporting may be improved C. Liaison with the external audit firm will improve its independence D. Internal control awareness will be enhanced within Cameron Co E F, Internal audit function effectiveness will increase through independent reporting lines. External risks faced by the business will be reduced. 2. For each of the following issues decide whether the matter is matters corporate governance strength or deficiency. Strength Deficiency 1. Mr Osbourne is the chair and chief executive of Cameron Co 2. Allof the current NEDs are independent 3. The finance director will head the newly formed audit committee 4. The remuneration of each director is decided by Mr Osbourne 3._For each of the following issues match to the appropriate response 1. The board is not balanced 2. Mr Osbourne is considering appointing his friend as a non- executive director Response: A. Anaudit committee should be set up immediately 8. Remuneration of executive directors should be performance related. C. Appointment of non executive should be based on experience, D. Appoint two more independent non executive directors, E. Reduce the number of executive directors on the board 4. Corporate governance is a system by which companies are directed and controlled. Board of directors is responsible for the governance of their companies. The role of the in Governance is to appoint the diractars and the auditors and to satisfy themselves that an appropriate governance structure is in place, The responsibilities of the include setting the company's strategies providing the leadership to put these strategies into effect and supervising the management of the business Select an appropriate word to complete the sentence, A. Chairmen 8, Shareholders C. Stakeholders D. Board of directors £, Nonexecutive F. Executives From the desk of Sir Ahmed Shafi: Panel Scanned with CamScannerwetiidWwald S HUD of Accountanc - Which of the following is NOT a principle of the UK Corporate Governance Code? There should be a rigorous and transparent procedure for the appointment of new directors to the board The board should use the AGM to communicate with shareholders ~ Atisk committee must be established to ensure effective risk management systems are established - + All directors should receive induction training on joining the board, All directors should receive regular training to ensure they maintain their skills and knowledge. Page 2 ‘Scanned with CamScannergeen Co IGN = oe —estinesees e teetoor excculives tho |. 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The listing rules of the stock exchange require compliance with corporate governance principles, and the directors are unsure whether they are following best practice In relation to this. They have asked the audit engagement partner for their view on this matter. Tangerine’s board is comprised of six executive directors, a non-executive chairman and three other non-executive directors (NEDs). The chairman and one of the NED’s are former executive directors of Tangerine and on reaching retirement age were asked to take on non-executive roles. The company has established an audit committee, and all NEDs are members including the chairman, who chairs the committee. All four members of the audit committee were previously involved in sales or productions related roles. All of the directors have been members of the board for at least four years. As the chairman does not have an executive role, he has sole responsibility for liasing with the shareholders and answering any of their questions. The company has not established an internal audit function to monitor internal controls. Required: Using the information above: Describe FIVE corporate governance weaknesses faced by Tangerine Tech Co and provide a recommendation to address each weakness to ensure compliance with corporate governance principles. Scanned with CamScannerory g Tey wall vob Jaen = 5 ce woes hc bre uns A arnee al be NO \ gatos 6 9-19 wiealknesse s Board & compred Ds, & NED Chun . % othe-WE De Tew ympes tearsk Unet he bcond mrekes decor in dra bet eecals ch tbe Co. 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The directors feel that the team needs to increase in size and specialist skills are required, but they are unsure whether to recruit more internal auditors, or to outsource the whole function to their external auditors, Cello & Co. Saxophone is required to comply with corporate governance principles in order to maintain its listed status; hence the finance director has undertaken a review of whether or not the company complies. Bill Bassoon is the chairman of Saxophone, until last year he was the chief executive. Bill is unsure if ‘Saxophone needs more non-executive directors as there are currently three non-executive directors out of the eight board members. He is considering appointing one of his close friends, who is a retired chief executive of a manufacturing company, as a non-executive director. The finance director, Jessie Oboe, decides on the amount of remuneration each director is paid. Currently all remuneration is in the form of an annual bonus based on the profits. Jessie is considering setting up an audit committee, but has not undertaken this task yet as she is very busy. A new sales director was appointed nine months ago. He has yet to undertake his board training as this is normally provided by the chief executive and this role is currently vacant. There are a large number of shareholders and therefore the directors believe that it is impractical and too costly to hold an annual general meeting of shareholders. Instead, the board has suggested sending out the financial statements and any voting resolutions by email; shareholders can then vote on the resolutions via email, Required: (a) Explain the advantages and disadvantages for each of Saxophone Enterprises Co and Cello & Co of outsourcing the internal audit department. {b) In respect of the corporate governance of Saxophone Enterprises Co: I. Identify and explain FIVE corporate governance weaknesses; and li, Provide a recommendation to address each weakness. 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Stark is regulated by the relevant financial services authority. You have been asked to start the audit planning for Stark Company by Mr. Son, a partner in Ali & Company. Mr. Son has been the engagement partner for Stark Company for the previous nine years and 0 has excellent knowledge of the client. Mr. Son has informed you that he would like his daughter Zoe to be part of the audit team this year; Zoe is currently studying for her first fundamentals papers for her ‘ACCA qualification. Mr. Son also informs you that Mr. Far, the audit senior, received investment advice from Stark Co during the year and intends to do the same next year. In an initial meeting with the finance director of Stark Co, you learn that the audit team will not be entertained on Stark Co's yacht this year as this cold appear to be an attempt to influence the opinion of the audit. Instead, he has arranged a balloon flight costing less than one-tenth of the expense of using the yacht and hopes this will be acceptable. The director also states that the fee for taxation services this year should be based on a percentage of tax saved and trusts that your firm will accept a fixed fee for representing Stark Co in a dispute regarding the amount of sales tax payable to the taxation authorities. Required: (a) Explain the ethical threats which may affect the auditor of Stark Co. (b) For each ethical threat, discuss how the effect of the threat can be mitigated. Ethical threats to independence and objectivity Threat Example Self-interest ‘© Close business ,family or personal relationships ‘+ Undue fee dependency on one client ‘% or contingent fees Low balling to win lucrative other work Overdue fees Gifts and hospitality Employment with an assurance client Partner on client board Loans and guarantees Financial interests in a client Holding client assets Self-review '* Provision of other non-audit services such as tax internal audit, validation services corporate finance IT systems services. Preparing financial statements and accounting records. Recent service with an audit client. ‘Advocacy ‘+ Promoting shares in a listed audit client 6|Page Scanned with CamScannerF8: AUDIT AND ASSURANCE SIR AHMED SHAFI © Acting as an advocate in a legal dispute Commenting publicity on future events in particular circumstances Familiarity ‘Long association with an audit/client Close business family or personal relationship Gifts and hospitality Intimidation Being threatened with removal as auditor Dominant person in senior position within the client Threat of litigation Threat of other lucrative non-audit work not being awarded 15 CODE OF ETHICS AND CONDUCT (a) Explain each of the five fundamental principles of ACCA’s Code of Ethics and Conduct. {b) Compliance with the fundamental principles in ACCA’s Code of Ethics and Conduct can be threatened in a number of ways. Required: {i) List the five ethical threats to independence and objectivity and for each threat identify one ‘example of a circumstance that may create the threat. 19 ORANGE (6/12) (AMENDED) You are the audit manager of Currant & Co and you are planning the audit of Orange Financials Co (Orange), who specializes in the provision of loans and financial advice to individuals and compani Currant & Co has audited Orange for many years. The directors are planning to list Orange on a stock exchange within the next few months and have asked if the engagement partner can attend the meetings with potential investors. In addition, as the finance director of Orange is likely to be quite busy with the listing, he has asked if Currant & Co can produce the financial statements for the current year. During the year, the assistant finance director of Orange left and joined Currant & Co as a partner. It has been suggested that due to his familiarity with Orange, he should be appointed to provide an independent partner review for the audit. Once Orange obtains its stock exchange listing it will require several appointments to be undertaken, for example, obtaining advice about corporate governance best practice. Currant & Co is very keen to be appointed to these engagements; however, Orange has implied that in order to gain this work Currant & Co needs to complete the external audit quickly and with minimal questions/issues. ‘The finance director has informed you that once the stack exchange listing has been completed, he ‘would like the engagement team to attend a weekend away at a luxury hotel with his team as a thank you for all the hard work. In addition, he has offered a senior member of the engagement team a short- term loan at a significantly reduced interest rate. 7|Page Scanned with CamScannerF8: AUDIT AND ASSURANCE SIR AHMED SHAFI Required: (2) Explain five ethical threats which may affect the independence of Currant & Co's audit of Orange Financials Co. (b) For each threat explain how it might be reduced to an acceptable level. 13 LV FONES (6/10) (AMENDED) You are the audit manager of Jones & Co and you are planning the audit of LV Fones Co, a listed ‘company which has been an audit client for four years and specializes in manufacturing luxury mobile phones. During the planning stage of the audit you have obtained the following information. The employees of LV Fones Co are entitled to purchase mobile phones at a discount of 10%. The audit team has in previous years been offered the same level of staff discount. During the year the financial controller of LV Fones was ill and hence unable to work. The company had no spare staff able to fulfill the role and hence a qualified audit senior of Jones & Co was seconded to the client for three months. The audit partner has recommended that the audit senior work on the audit as he has good knowledge of the client. The fee income derived from LV Fones was boosted by this engagement and along with the audit and tax fee, now accounts for 16% of the firm’s total fees. From a review of the correspondence files you note that the partner and the finance director have known each other socially for many years and in fact went on holiday together last summer with their families. As a result of this friendship the partner has not yet spoken to the client about the fee for last year’s audit, 20% of which is stil outstanding. Required: {a) Explain the ethical threats which may affect the independence of Jones & Co's audit of LV Fones Co. (b) For each threat explain how it might be avoided. 8|Page Scanned with CamScannerSection B - ALL SIX questions are compulsory and MUST be attempted Please write your answers to all parts of these questions on the lined pages of the Candidate Answer Booklet. 1 You are an audit manager of Pink Partners & Co (Pink) and are planning the audit of Golden Finance Co (Golden), a banking institution which provides a range of financial services including loans. Your firm has audited Golden for four years and the company’s year end is 30 September 2015. At the end of August, Golden’s financial controller left and the new replacement is not due to start until approximately two months after the year end. The finance director, who is the sister-in-law of the audit engagement partner, has asked if a member of the audit team can be seconded to Golden for three months to act as the temporary financial controller, You are aware that a number of the audit team members currently bank with Golden and two team members have significant loans owing to the company. Pink's taxation department also provides services to Golden. They have been approached by Golden to represent them in negotiations to resolve some outstanding issues with the taxation authorities, for which the fees quoted are substantial, The finance director has informed the audit engagement partner that when the audit is complete, she would like the whole team to attend an evening watching the national football team play a match followed by a luxury meal. Required: Using the information above: () Identify and explain FIVE ethical threats which may affect the independence of Pink Partners & Co's audit of Golden Finance Co; and (li) For each threat, explain how it might be reduced to an acceptable level. Note: The total marks will be split equally between each part. (LO marks) Scanned with CamScanner8; AUDIT AND ASSURANCE ‘SIR AHMED SHAFI 16 STARK (12/08) (AMENDED) You are the manger in the audit firm of Ali and co; and this is your first time yau have worked an one of the firm's established clients , Stark Co. the main activity of Stark Co. is providing investment advice to individuals regarding saving for retirement, purchase of shares and securities and investing in tax efficient savings schemes. Stark is regulated by the relevant financial services authority. You have been asked to start the audit planning for Stark Company by Mr. Son, a partner in Ali & ‘Company. Mr. Son has been the engagement partner for Stark Company for the previous nine years and so has excellent knowledge of the client. Mr. Son has informed you that he would like his daughter Zoe to be part of the audit team this year; Zoe is currently studying for her first fundamentals papers for her ACCA qualification. Mr. Son also informs you that Mr. Far, the audit senior, received investment advice from Stark Co during the year and intends to do the same next year. In an initial meeting with the finance director of Stark Co, you learn that the audit team will not be entertained on Stark Co's yacht this year as this cold appear to be an attempt to influence the opinion of the audit. Instead, he has arranged a balloon flight costing less than one-tenth of the expense of using the yacht and hopes this will be acceptable. The director also states that the fee for taxation services this year should be based on a percentage of tax saved and trusts that your firm will accept a fixed fee for representing Stark Co in a dispute regarding the amount of sales tax payable to the taxation authorities. Required: (a) Explain the ethical threats which may affect the auditor of Stark Co. (b) For each ethical threat, discuss how the effect of the threat can be mitigated. Ethical threats to independence and objectivity Threat Example Self-interest ‘© Close business family or personal relationships Undue fee dependency on one client % or contingent fees Low balling to win lucrative other work Overdue fees Gifts and hospitality Employment with an assurance client Partner on client board Loans and guarantees Financial interests in a client Holding client assets ‘Self-review Provision of other non-audit services such as tax internal audit validation services corporate finance IT systems services. Preparing financial statements and accounting records. © Recent service with an audit client. ‘Advocacy, ‘¢ Promoting shares in a listed audit client 6|Page Scanned with CamScannersas in the audit Required: (a) Explain the safeguards that your firm should implement to ensure that this conflict of interest is properly managed. (4 marks) intemal audit department of five emoloyees but they have struggled to unde fequited by the company, hence Gooty Ca is consider the intemal audit department, If Controls at the various or to outsource sits to test ead office. @ whether to recruit to curced, Goofy Co would require a team to ut ops across the country, and to perform ad hoc operational reviews at shot Gooly Co ts considering using NAB & Co to provide the intemal audit services as well as remain as external auditors. Required: (b)_ Discuss the advantages and disadvantages to both Goofy Co and NAB & Co of outsourcing their internal audit department. (10 mars) (c) The audit engagement partner for Goaty Co has been in place for approximately six years and her son has just accepted a job offer trom Gooty Co as a sales manages; this role would entitle him to shares in Goofy Co as part of his remuneration package. If NAB & Co 1s appointed as internal as well as external auditors, then Goofy Co has suggested that the external audit fee should be renegotiated with at least 20% of the fee being based on the profit after tax of the company as they tee! that this will align the interests of NAB & Co and Goofy Co. Required: From the information in (c) explain the ethical threats which may affect the independence of NAB & Co in respect of the audit of Goofy Co, and for each threat explain haw it may be reduced. (6 marks) (20 marks) Scanned with CamScannerSalt & Pepper & Co Salt & Pepper & Co [Salt & Pepper I firm of Chartered Certified Accountants which has been Its revenue decline steadly over the past few years. The frm Is looking to Increase its revenue and client base and so has developed a new advertising strategy where ithas guaranteed that its audit will, ‘minimize cisruption to companies as they wil not ast longer than two weeks. In alton, Salt & Pepper has offered all new aut clients a free accounts preparation service for te fist year of engagement as itis believed thatthe te pent onthe aut will be reduced ifthe frm has produces firancial, statements, ‘The firm is seeking to reduce the audit costs and has therefore decided not to update the engagement letters of ensting clients, on the basis that these letters donot tend to change much ona yearly bass. ‘One of Salt & Pepper's existing cient sas proposed that this year's aust fee should be based on 8 ia[Page 8: AUDIT AND ASSURANCE SIRAHMED SHAFI percentage of thelr inal pre-tax profit. The partners are excited about this option as they believe it will Increase the overall aust fee. Salt & Pepper has recently obtained a new audit client, Cinnamon Brothers Ltd (Cinnamon), whose year ‘end 31" December. Clnnamon requires their aut tobe completed by the end of February; however, this a very busy time for Salt & Pepper and sot intended to use more junior staff as they are ‘availabe. Adltionaly in order to save time and cost, alt & Pepper have not contacted Cinnamon’s Previous auditors Required: (2) Describe the steps that Salt & Pepper should take in relation to Gnnamon: |. Prior to accepting the audit; and i, To confirm whether the preconditions forthe auit aren place. (8) State FOUR matters that should be included within an audit engagement letter. {e) Identify and explain FIVE ethical sks which arise from the above ations of Salt &Pepper & co:and For each ethical risk explain the steps which Salt a8 Pepper & Co should adopt to reduce the Fike arising. "Note: the total mark willbe spit equaly between each part. 112 GOOFY (6/31) (AMENDED) Yu ae an aut manager in NAB & co large aut frm which specializes inthe auc of retailers. The fir cutrently audits Goofy Co, 2 food retailer, but Goofy Co's main competitor, Mickey Co, has approached the aut frm to act as auditors. Both companies ae highly competitive and Goofy /co is concerned that if NAB & Co. auits both comparies then confidential information could pass across to ‘Mickey Co. Required: (2) Explain the safeguards that your firm should implement to ensure that this conflict of interest is property managed. Goofy Co's year end is 31 December, whichis traditionally a busy ime for NAB & Co. Goofy Co currently has an internal audit department of five employees but they have strugped to undertake the variety ‘and extent of work required by the company, hence Goofy Coisconsiering whether to recruit to ‘expand the department or to autsource the internal audit department. outsourced, Goofy Co would Fequire a team to undertake monthly vss to test controls atthe various shops across the country, and ‘to perform a6 hoc operational reviews at shops and head office Goofy co is considering using NAB & co to provide the internal aut services as well as remain as external auditors. Required (b) biscuss the advantage and dlsadvantages to both Goofy Co and NAB & co of outsourcing thelr Internal audit department. Please write your answers to all pats ofthese questions onthe lined pages ofthe Cendidate ‘Answer Booklet. 15 [Page Scanned with CamScannerF8: AUDIT AND ASSURANCE ‘SIR AHMED SHAFI INTERNAL AUDIT OUTSOURCING THE INTERNAL AUDIT FUNCTION Rather than having a permanent internal audit presence some organization have chosen to outsource the function (acquiring the service from a third party) such that they would buy in necessary skills as, they are needed for specific pieces of work. Background behind outsourcing is the fact that companies cannot afford to have certain department on permanent basis e.g. It security, Cafeteria, Human resource, repair Maintenance, internal audit and payroll department etc. (Mostly those functions are outsourced that are not core departments of the organizations). ADVANTAGES OF OUTSOURCING 1. Internal audit staff does not need to be permanently recruited or hired. 2. Internal audit staff can be used for a wider range of services. Outsourcer provides specialist service. 4, Outsourcer provides immediate service. 5. Skills required for only a short period of time each year can be provided without incurring the excessive costs of maintain an in house development. 6. Outsourcer could provide access to new techniques without the need for significant levels of investment or in house development. 7. With a professional outsourced department, less management time is required on internal audit activities e.g. appraisals, training and development. 8. Associated cost such as training costs and hiring costs are eliminated. 9. Service can be acquired for the desired period as per the needs of company. 10. Service provider will also indemnify in case of loss to the company. 11. Outsourcing lays the basis of a permanent function by setting such policies and functions. DISADVANTAGES OF OUTSOURCING 1. Conflict of interest plus independence & objectivity issues may rise if the outsourced internal audit service is being provided by the company’s external auditors. 2. Outsourced may be expensive to the company as service is being acquired from a professional service company. 3, An outsourced department may not be as flexible when problem arise, since they do not have a permanent presence. 4, Standard of service may not be up to the requirement of the company. 5. There is a risk of lack of knowledge, awareness or proper understanding of the organization objectives and its culture. 6. Loss of in house skills, company staff may oppose outsout made redundant. 7. Lack of control over the audit staff of the outsourced firms. 8. Lack of loyalty may be an issue. ing if it results in existing staff being 17|Page Scanned with CamScannerF8: AUDIT AND ASSURANCE ‘SIR AHMED SHAFI CONCLUSION There are number of problems associated with outsourcing, the major one being a possible impairment of independence. ‘According to some authors, outsourcing of internal audit is not an effective business solution and that outsourcing will ultimately increase the costs of company with no added loyalty to the company. Therefore, the company management should think hard before outsourcing their internal audit department. MAJOR ADVANTAGES/ BENEFITS OF HAVING AN INTERNAL AUDIT DEPARTMENT 1. Itdispenses the need to employ consultants to act as internal auditors hence saving large sum of ‘money. This is even especially true when an internal audit department is properly run with well trained and experienced internal auditors. 2. The internal auditors are intimately acquainted with the business as they are continuously employed in the same concern and have access to much confidential information and to all levels of management. Hence, they really are special personnel who have very in depth inner knowledge which can contribute to the company. 3, The internal audit maintains a group of highly skilled people available to cope with non- recurring and exceptional jobs which no employees could deal with efficiently and effectively. 4, Itensures that the organizations detailed standard policy and procedures are running smoothly. This compared to the external auditors primary role of the ability to express the true and fair view of the client's financial statement aut 5. It provides an excellent training ground for establishing and producing future executives for the company. LIMITATIONS OF AN INTERNAL AUDIT FUNCTION: > Reporting Mechanism: There is a limitation if the Internal Audit function is reporting only to CEO. Instead there should be a dual reporting mechanism i.e. their function must report functionally to audit committee for other matters to CEO. > Qualification of Internal Auditors: There is no mandatory requirement for qualification of Internal Auditors, therefore there may be a limitation due to lack of knowledge. > Scope of work of internal Auditors: define by 8.0.0. ns of scope of work of Internal Audit department, if such scope > Auditing your own work: {twill impose or create a self review threat. If Internal Audit function is reviewing /audit their own work. > Length of Service: 18|Page Scanned with CamScanner8: AUDIT AND ASSURANCE SIR AHMED SHAFI Due to long length of service and repetition of work, internal auditors become over familiar with their work. > Independence of internal Auditors: Internal Auditors are ultimately employees of the company therefore they cannot be expected to have some level of independence as External Auditors. > No standardization or uniformity exists Internal Audit Functions; therefore the work of Internal Auditors and formats of their reports will vary from company to company. > Due to its huge fixed cost, lots of companies do not encourage or appreciate to have permanent Internal Audit Department. > There might be resistance from various departments and employees to have an Internal Audit department as their work will be reviewed and criticized by Internal Audit department. There is less reliance on the work of internal auditors than external parties and stakeholders, as for those internal auditors on substance are employees of the company. PRACTICE QUESTIONS: v 17 Governance SPD Co has been trading for 10 years and provides advice on pensions and other financial products to its clients. SPD Co is not listed on stock exchange but it’s regulated by @ government body which aims to ensure that financial advice is always provided in the best interests of the customer. ‘SPD Co has seen rapid growth in its revenue over the last 12 months and expects this trend to continue. In order to meet client demand and offer new products, SPD Co is now offering more complex financial products than it has ever done before. ‘SPD Co is also in need of additional funding to support its anticipated growth and will shortly need to approach its bank to determine whether additional funding might be available. The Board of Directors is also considering bank to determine whether or not SPD Co should obtain the listing on a stock exchange a an alternative way of raising finance. (2) Explain what is meant by ‘corporate governance’ and explain why it is important. (b) Discuss the benefits to SPD Co of establishing an internal audit department. 20 Internal audit functions (2) List the types of activity normally carried out by internal audit departments. (b) Briefly explain the main differences between internal and external auditors in respect of objectives, scope of work and reporting responsibilities. (c) Explain the term ‘outsourcing’ and list three advantages and three disadvantages of outsourcing an internal audit department. 19|Page Scanned with CamScannerF8: AUDIT AND ASSURANCE SIR AHMED SHAFI 24 Wood Industries (AIR 6/05) (amended) You are the audit manager of Wood Industries Co (Wood), a limited liability company. The company’s. annual revenue is over $10 million. Required: (a) Compare the responsibilities of the directors and auditors regarding the published financial statements of Wood. (b) The directors of Wood have prepared a cash flow forecast for submission to the bank. They have asked you as the auditor to provide a limited assurance report on this forecast. Required: Briefly explain the difference between reasonable and limited assurance. 25 Regulations and limitations (12/12) (amended) (a) In order for auditors to operate effectively and to provide an opinion on an entity's financial statements, they are given certain rights. Required: State three rights of an auditor, excluding those related to resignation and removal. (b) Explain the overall authority of International Standards on Auditing (ISAs) and how they are applied in individual countries. (c) Describe three limitations of external audits. 21 Internal audit responsibilities {a) There are similarities and differences between the responsibilities of internal and external auditors. Both internal and external auditors have responsibilities relating to the prevention, detection and reporting of fraud, for example, but their responsibilities are not the same. Required Explain the difference between the responsibilities of internal auditors and external auditors for the prevention, detection and reporting of fraud and error. {b) ISA 610 Using the work of internal auditors provides guidance to external auditors when accessing whether to place reliance on work performed by internal audit. Req Explain factors which should be considered by external auditors before placing reliance on work of internal auditors 20|Page Scanned with CamScannerF8: AUDIT AND ASSURANCE SIR AHMED SHAFI 22 Monte Hodge (6/08) (amended) Monte Hodge Co has total revenue of $253 million and employs 1,200 people in 15 different locations. ‘The company provides various financial services, from giving pension and investment advice to individuals, to maintaining cash books and cash forecasting in small to medium-sized companies. It is ‘owned by six shareholders, who belong to the same family; itis not listed on any stock exchange and the shareholders have no intention for applying for a listing. However, and annual is required by statute and additional regulation of the financial services sector is expected in near future. Most employees are provided with online, real time computer systems, which present financial and stock market information to enable the employees to provide up-to-date advice to their clients. ‘Accounting systems record income, which is based on fees generated from investment advice. Expenditure is mainly fixed, being salaries, office rent, lighting and heating, etc. internal contro! systems are limited; the directors tending to trusts staff and being more concerned with making profits than implementing detailed controls. Four of the shareholders are board members, with one member being the chairman and chief executive officer. The financial accountant is not qualified, although has many years experience in preparing financial statements. Required Discuss the arguments for and against having an internal audit department in Monte Hodge Co. 23 Avocado (6/12) (amended) Avocado International Co (Avocado) is a manufacturer of African-inspired wooden toys. You are an audit manager of Lime & Co, Avocado’s external auditor. (a) Avocados finance director has expressed an interest in Lime & Co performing other review ‘engagements in addition to the external audit. However, he is unsure how much assurance would be gained via these engagements and how this differs to the assurance provided by an external audit. Required Identify and explain the level of assurance provided by an external audit and other review engagements. ‘Avocado's directors are considering establishing an internal audit department next year, and the finance director has asked about the differences between internal audit and external audit and what impact, if any, establishing an internal audit department would have on future external audits performed by Lime & Co, Required (b) Distinguish between internal audit and external audit. (c) Explain the potential impact on the work performed by Lime & Co during the interim and final audits, if Avocado International Co was to establish an internal audit department. 21[ Page Scanned with CamScanner