Auditing Cases 2020 PDF

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Warning: TT: undefined function: 32 Warning: TT: undefined function: 32AUDITINGCASESTABLE OF CONTENTSMoney Laundering Independence Familiarity Threat Fraud Risk Factors Monitoring Client Acceptance Documentation Requirements Materiality Risk of Material Misstatement Management’s Representations Anal...

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AUDITING CASES TABLE OF CONTENTS Money Laundering Independence Familiarity Threat Fraud Risk Factors Monitoring Client Acceptance Documentation Requirements Materiality Risk of Material Misstatement Management’s Representations Analytical Procedures Opening balance and comparatives

MONEY LAUNDERING You are the audit manager of Pegasus Company, a chain of night clubs across the Philippines. During the course of the audit, Mr. Steve, an employee of the company, informed you that a substantial cash deposit was paid into the company’s bank account and a month later, the same amount was paid by direct transfer into a bank account in the name of Evissa, a company based overseas. The employee also informed you that Mr. Rey, the managing director of Pegasus Company had instructed him not to record the transaction in the accounting records as it had nothing to do with Pegasus Company. Is there money laundering? Answer: The scenario raises suspicion of money laundering for several reasons: 1. It has been alleged by Mr. Steve that the purpose of the transaction has nothing to do with the night club business. This could be a sign that Mr. Rey is attempting to legitimize the proceeds of a crime through Pegasus Company by concealing the illegal source of the cash. 2. The amount of the transaction is substantial for Pegasus. An unusually large transaction should alert the auditor for the possibility of money laundering, especially as it does not seem to relate to the business of Pegasus Company. 3. The cash amount paid into Pegasus Company’s bank account is the same as the amount paid to Evissa. This could be an attempt by Mr. Rey to make the cash appear legitimate by moving it through several companies and jurisdictions. 4. Mr. Steve was instructed not to record the transaction in the accounting records of Pegasus Company. Increased secrecy over transactions is another indicator of money laundering. 5. Pegasus bank account should be checked to confirm Mr. Steve’s assertion. The suspicious transaction should be reported as soon as possible. It is criminal offense to not report suspicions of money laundering.

INDEPENDENCE You are a Partner at SGV & Co. The following situations exist. 1. Teresa is the audit manager assigned to the audit of Xurpas, a publicly listed company. The audit has been on-going for one week. Yesterday, Teresa’s husband inherited 1,000 shares in Xurpas. Teresa’s husband wants to hold on to the shares as an investment. 2. SGV & Co. retirement fund, which is administered by Metrobank owns shares in Villar Company, a listed company with a number of subsidiaries. SGV has recently been invited to tender for the audit of one of the subsidiary companies, Camella Acres. Comment on the ethical and other professional issues raised by the above matters: Answer: 1. Teresa is at present a member of the assurance team and a member of her immediate family who owns a direct financial interest in the audit client. This is unacceptable. In order to mitigate the risk to independence that this poses on the audit, SGV & Co. needs to apply any one of the two safeguards: a. Ensure that the connected person divests the shares. b. Remove Teresa from the engagement team. Teresa should be appraised that these are the options and removed from the team while a decision is taken whether to divest the shares. Teresa’s husband appears to want to keep the shares, in which case, Teresa should be removed from the team immediately. The firm should appraise that these are the options of Xurpas of what has happened and the actions they have taken. The partners should consider whether it is necessary to bring in an independent partner to review audit work. Given that Teresa’s involvement is subject to the review of the existing engagement partner and she was not connected with the shares while she was carrying out the work, a second partner review is likely to be unnecessary in this case. 2. The audit firm has an indirect interest in the parent company of a company it has been invited to tender for by virtue of its retirement fund having invested in Villar Company. There is no barrier to the audit firm tendering for the audit of Camella Acres. FAMILIARITY THREAT You are a partner in a firm. The following issues have emerged in relation to three of your clients: 1. Easter is a major client. It is listed in the Philippine Stock Exchange. The audit team consists of eight members, of whom Paul is the most junior. Paul has just invested in a personal retirement plan that invests in all the listed companies on the exchange. 2. You are at the head of the team carrying out due diligence work at Electra which your client is considering taking over. Your second in command on the team, Peter, has confided in you that in the course of his work he has met the daughter of the managing director of Electra, and he is keen to invite her on a date.

3. Your longest standing audit client is Teddies, which you have been involved on for ten years, four as engagement partner. You recently went on a cruise with the managing director. Comment on the ethical and other professional issues raised by the above matters: Answer: 1. In relation to Easter, there is a threat of self-interest arising, as a member of the audit team has an indirect financial interest in the client. The relevant factors are as follows: a. The interest is unlikely to be material to the client or Paul, as the investment is recent, and Paul’s interest is in a pool of general investments made in the exchange on his behalf. b. Paul is the audit junior and does not have a significant role on the audit in terms of drawing audit conclusions or audit risk areas. The risk arises to the independence of the audit here is not significant. It would be inappropriate to require Paul to divest his interest in the audit client. If I wanted to eliminate all elements of risk in this situation, I could simply change the junior assigned to my team, but such a step is not vital in this position. 2. In relation to Powerful, two issues arise. The first is that the firm appears to be providing multiple services to Powerful, which could raise a self-interest threat. The second is that the manager assigned to the due diligence assignment wants to engage in a personal relationship with a person connected to the subject of the assignment, which could create a familiarity or intimidation threat. With regard to the issue of multiple services, insufficient information is given to draw a conclusion as to the significance of the threat. Relevant factors would matter such as the nature of the services, the fee income and the team members assigned to each. Safeguards could include using different staff for the two assignments. The risk is likely to be significant only if one of the services provided is audit, which is not indicated in the question. In relation to the second issue, the relevant factors are these: a. The assurance member has a significant role on the team as second in command. b. The other party is closely connected to a key staff member at the company being reviewed. c. Timing In this situation, the firm is carrying out a one-off review of the company, and timing is a key issue. Presently, Peter does not have a personal relationship which could significantly threaten the independence of the assignment. In this situation, the safeguard is to request that Peter does not take any action in that direction until the assignment is completed. If he refuses, then I may have to consider rotating my staff on this assignment and removing him from the team. 3. In relation to Teddies, there is a risk that my long association and personal relationship with the client will result in a familiarity threat. This is compounded by my acceptance of significant hospitality on a personal level.

The relevant factors are: a. I have been involved with the client for ten years and have a personal relationship with the client staff. b. The company is not a listed public interest company c. It is an audit assignment The risk arising here is significant, but as the client is not listed, it is insurmountable. However it would be a good idea to implement some safeguards to mitigate against the risk. I could invite a second partner to provide a hot review of the audit of Teddies, or even consider requesting that I am rotated off the audit of Teddies for a period, so that the engagement partner is another partner in my firm. In addition, I must cease accepting hospitality from the directors of Teddies unless it is clearly insignificant. FRAUD RISK FACTORS You are an audit manager for Elle and Emm. You are carrying out the planning of the audit of Sellfones Company, a listed company, and a high street retailer of mobile phones, for the year ending September 30, 2020. The notes from your planning meeting with Jameson, the CFO, include the following: 1. One of Sellfones’ main competitors ceased trading during the year due to the increasing pressure on margins in the industry and competition from online sellers. 2. A new management structure has been implemented, with 10 new divisional managers appointed during the year. The high street shops have been allocated to these managers, with approximately 20 branch managers reporting to each divisional manager. The divisional managers have been set challenging financial targets for their areas with substantial bonuses offered to incentivize them to meet the targets. The board of directors have also decided to cut the amount that will be paid to shop staff as a Christmas bonus. 3. In response to recommendations in the prior year’s Report to Management, a new inventory system has been implemented. There were some problems in its first months of operation, but a report has been submitted to the board by Melanie, the chief accountant, confirming that the problems have all been resolved and that information produced by the system will be accurate. Jameson commented that the chief accountant had to work very log hours to deal with this new system, often working at weekends and even refusing to take any leave until the system was running properly. 4. The Company is planning to raise new capital through a share issue after the year-end in order to finance expansion of the business into other countries. As a result, Jameson has requested that the auditor’s report is signed off by December 15, 2020 (six weeks earlier than in previous years). 5. The latest board summary of results includes: 9 months to In millions June 30, 2020 Revenue P320 Cost of sales 215 Gross profit P105 Operating expenses (89) Extraordinary gain on sale 30 Profit before tax P 46

September 30, 2019 (audited) P280 199 P 81 (70) P 11

6. Several shop properties owned by the company were sold under sale and leaseback arrangements. Identify and explain any fraud risk factors that the audit team should consider when planning the audit. Answer: In this scenario, there are a large number of factors that should alert the auditors to the possibility of misstatements arising from fraudulent financial reporting, and others that could indicate a risk of misstatements arising from misappropriation of assets. 1. Operating conditions within the industry The failure of a competitor in a highly competitive business sector highlights the threat to the survival of a business such as Sellphones and this could place the directors under pressure to overstate the performance and position of the company in an attempt to maintain investor confidence, particularly given the intention to raise new share capital. 2. Management structure incentives It is not clear in the scenario how much involvement the new divisional manager have in the financial reporting process, but the auditors would need to examine any reports prepared or reviewed by them very carefully as their personal interest may lead them to overstate the results in order to earn their bonuses. 3. New inventory system/chief accountant The problem with the implementation of the new inventory system suggest that there may have been control deficiencies and errors in the recording or inventory figures. Misstatements, whether deliberate or not, may not have been identified. The amounts of time spent by the chief accountant on the implementation of the new inventory system could be seen as merely underlining the severity of the problems, but the fact that she has not taken any leave should also be considered as suspicious and the auditors should be alert to any indication that she may have been involved in any deliberate misstatement of figures. 4. Results The year on year results look better than might be expected given the business environment. The gross profit margin has increased to 32.8% and the operating profit margin has increased to 5%. This seems to conflict with what is known about the industry and should increase the auditor’s professional skepticism in planning the audit. 5. Exceptional gain The sale and leaseback transaction may involve complex considerations relating to its commercial substance. It may not be appropriate to recognize a gain, or the gain may have been miscalculated.

6. Time pressure on audit The auditors should be alert to the possibility that the tight deadline may have been set to reduce the amount of time the auditors have to gather evidence after the end of the reporting period, perhaps in the hope that certain deliberate misstatements will now be discovered. 7. Risk of misappropriation of assets The nature of the inventory held in the shops increases the risk that staff may steel goods. This risk is perhaps increased by the fact that the attitude of the staff towards their employer is likely to have been damaged by the cut in their Christmas bonus. The problems with the new inventory recording system increase the risk that any such discrepancies in inventory may not have been identified. MONITORING You are an audit senior working for Isla Lipana. You are currently carrying out the audit of Plastics Incorporated, a manufacturer of plastic bags. You are unhappy with Plastics’ inventory valuation policy and have raised the issue several times with the audit manager. He has dealt with the client for a number of years and does not see what you are making a fuss about. He has refused to meet you on site to discuss these issues. The former engagement partner to Plastics retired two months ago. As the audit manager had dealt with Plastics for so many years, the other partners have decided to leave the audit of Plastics in his capable hands. What do you think? Answer: Several quality control issues are raised: Engagement partner An engagement partner is usually appointed to each audit engagement undertaken by the firm, to take responsibility for the engagement on behalf of the firm. Assigning the audit to the experience audit manager is not sufficient. Conflicting views In this scenario, the audit manager and senior have conflicting views about the valuation of the inventory. This does not appear to have been handled well, with the manager refusing to discuss the issue with the senior. CLIENT ACCEPTANCE You are a partner of Manabat and Co. You have just successfully tendered for audit Mang Inasal. The tender opportunity was received cold, that is,, the company and its officers are not known to the firm. The company has just been incorporated and has just previously had an audit. You are about ready to accept nomination.

In the course of your acceptance procedures, you received a reference form a business contact of yours concerning one of the five directors of Mang Inasal, Mr. Simon. It stated that your business contact had done some personal tax work for Mr. Simon ten years previously, when he had found Mr. Simoon of being economical with the truth when it came to his tax affairs. As a result of this distrust, he had ceased to carry out work for him. What will you do? Answer: 1. The following procedures should be carried out: a. Ensure that I and my audit team are professionally qualified to act and consider whether there are ethical barriers to may accepting nomination. b. Review the firm’s overall work program to ensure that there are sufficient resources to enable my firm to carry out the audit. c. Obtain references about the directors as they are now known personally by me or anyone else in my firm. 2. The auditor must use his professional judgment when considering the response he gets to references concerning new clients. Matters to be considered a. The issue that the director has been difficult to maintain a relationship with in the past. b. The issue that the director was slow to provide information in the past. c. The suspicion of lack of integrity in relation to his tax affairs. At this stage he should be considering how highly he values the opinion of the one who referred. That should have been considered before he sent the reference. At this stage he should only be considering the implication of the reference for his current decision. Auditing a company is different from auditing personal affairs in terms of obtaining information and contacting personnel. In this case, the key issue is the question over the integrity of the director. As we do not have information about interim references and details of the business arrangements it is difficult to give a definite answer to this issue. However, Mr. Simon is likely to only have limited control over decisions of the entity being one of the five directors, which might lead to the auditor deciding that the reference was insufficient to prevent him accepting nomination. If Mr. Simon were the finance director, the auditor would be more inclined not to take the nomination. DOCUMENTATION REQUIREMENTS You have been informed by the senior partner of your firm that you are to be in charge of the audit of the new client, Peppermint Chews, for the year ended December 31, 2020. She tells you that the company is engaged in the manufacture and wholesaling of sweets and confectionery, with revenue of approximately P10,000,000 and a workforce of about 150. The company has one manufacturing location, sells mainly to the retail trade but also operates 10 shop of its own. The senior partner asks you to draw up an outline of

audit plan for the assignment showing when you anticipate visits to the client will be made and what kind of work will be carried out during each visit. The deadline for your audit is February 28, 2021. Draw up an outline plan for the audit of Peppermint Chews for the year ended December 31, 2020 including 1. Approximate timing in the company’s year of each stage of the audit of this new client. 2. The objective of each stage. 3. The kind of work that will be carried out at each stage. Answer: Initial Visit 1. Timing. As this is a new client, this visit should take place as soon as possible after the terms of engagement have been agreed with and accepted by the directors of Peppermint Chews. 2. Objective. To build up background knowledge of the company to assist in the more detailed planning of audit work that will be required at a later stage. 3. Audit work. We shall need to obtain details of the following: a. b. c. d. e. f.

The history and development of the company The nature of the commercial environment within which the company operates The nature of the company’s products and manufacturing processes The plan of organization within the company The accounting and internal control systems operating within the company The accounting and other records of the company and how they are maintained

The above will be obtained using such techniques as interview, observation, reviewing client’s systems documentation and many others. Interim Visit 1. Timing. As this is the first audit of Peppermint Chews, it may, in view of the extra work involved, be necessary to have more than one interim visit. If we decided that only one such visit would be needed, however, then ideally it should take place reasonably close to the year end, in say, October 2020. If it were decided that more than one visit were needed, then perhaps the first interim visit should take place in April or May 2020. 2. Objective. The purpose of interim audits is to carry out detailed tests on a client’s accounting and internal control systems to determine the reliance that may be placed thereon. 3. Audit wo...