Solution (Ch 1,2) PDF

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Solutions to week 1 tutorial work...

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ACCT3322 SEMESTER 2, 2018

Answers to the Tutorial Questions Chapters 1 and 2

Questions 1.33 You have recently graduated from your university course and start work with an audit firm. You meet an old school friend, Nga, for dinner — you haven’t seen each other for several years. Nga is surprised that you are now working as an auditor because your childhood dream was to be a ballet dancer. Unfortunately, your knees were damaged in a fall and you can no longer dance. The conversation turns to your work and Nga wants to know how you do your job. Nga cannot understand why an audit is not a guarantee the company will succeed. Nga also thinks that company managers will lie to you in order to protect themselves, and as an auditor you would have to assume that you cannot believe anything a company manager says to you. Required (a) Write a letter to Nga explaining the concept of reasonable assurance, and how reasonable assurance is determined. Explain why an auditor cannot offer absolute assurance. (b) Explain in the letter to Nga the concept of ‘professional scepticism’ and how it is not the same as assuming that managers are always trying to deceive auditors. Solution: (a) Write a letter to Nga explaining the concept of reasonable assurance, and how reasonable assurance is determined. Explain why an auditor cannot offer absolute assurance. There is a gap between Nga’s expectations and the level of auditor performance. An audit provides reasonable assurance, not absolute assurance. The audit enhances the reliability and credibility of the information included in a financial report but is not a guarantee that the financial report is free from error or fraud, or that the company will not fail. Partly, this is because of the nature of financial reporting. It requires judgements about accounting estimates and the choice and application of various accounting methods. There is usually not one ‘right’ answer for a company’s profit. The auditor cannot guarantee the profit reported by the company is ‘right’, only provide assurance about the appropriateness of the accounting method selection and application and the accounting estimates. Another reason the assurance is not absolute is the nature of the audit process. Auditors cannot review every transaction and account balance, therefore they use sampling (which could mean that representative items are not selected for testing). Some transactions and balances are difficult to gather reliable evidence about, clients can conceal evidence, and auditors have a limited time frame in which to complete the audit.

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ACCT3322 SEMESTER 2, 2018

(b) Explain in the letter to Nga the concept of ‘professional scepticism’ and how it is not the same as assuming that managers are always trying to deceive auditors. Professional scepticism is required of an auditor. It is an attitude that requires the auditor to remain independent of the client and its staff. The auditor has a questioning mind and thoroughly investigates all evidence presented by their client. This does not mean that they regard the client as a liar, but that they need to do more than simply take the client’s word about anything. Usually, there will be confirming evidence which supports the client’s statements (e.g. copies of contracts, minutes of meetings, etc.). Evidence gathered from independent third parties is generally regarded as more reliable than that gathered from the client. Managers will not always try to deceive auditors, but auditors must take the responsibility of gathering evidence to verifying managers’ statements. The auditor needs to be alert to the fact that some managers will try to deceive auditors sometimes. Question 2.23 Charles is at a neighbourhood Christmas party with several of his flatmates. Over a few beers, Charles gets into a conversation with a neighbour, William, about mutual acquaintances. Charles is a junior auditor with a large accounting firm (although he tells William that he is a partner at the firm) and William works for a large bank. During the conversation Charles and William discover that they have both had professional dealings with a particular family-owned manufacturing company. William reveals that the company’s line of credit is about to be cancelled because of some irregularities with the security documents. Charles is concerned to hear this news because he has just participated in the company’s financial report audit and there was no indication of any problems with its borrowings. Charles tells William that he believes that the founder of the family-owned company (and the current CEO) is having an affair with his personal assistant, and has quietly increased his shareholdings in a listed company that supplies components to the family manufacturing company. The components manufacturing company is about to announce to the share market that it has just won a very large, and very profitable, contract with a Chinese company. Required Discuss the ethical principles that are potentially breached by Charles’s behaviour at the party. Solution: The fundamental ethical principles that apply to all members of the professional bodies are to act with integrity, objectivity, professional competence and due care, confidentiality and professional behaviour (APES 110, 100.4). Charles overstates his importance at the audit firm – he states that he is a partner but he is a junior auditor. Breach of integrity Charles tells William that the founder of the family is having an affair with his personal assistant – this is gossip. Even if it is true, it is not professional behaviour to reveal private matters about a client to another party. 2

ACCT3322 SEMESTER 2, 2018 Charles tells William that the family has increased its shareholding in another company, with potential benefits to the company. This information appears to have been gained as part of the audit so revealing it to William is a breach of confidentiality. It is not relevant that William works for a bank which lends to the client, Charles does not have the client’s permission to discuss this matter. Question 2.29 Kerry is a senior auditor and a member of the team auditing a long-standing client, the listed public company Darcy Industries Ltd. Darcy Industries has just announced a takeover bid for Blacklight Ltd. Kerry has a substantial shareholding in Blacklight through his self-managed superannuation fund. Kerry did not know about the takeover bid until he read it in the paper over breakfast one morning. Kerry’s wife is very worried because she knows that Kerry must abide by strict rules laid down by his audit firm about holding shares in client companies. She asks him if he will be dismissed because of this. Required Advise Kerry’s wife of the options available to Kerry to avoid any conflict of interest, and thus avoid being dismissed from the audit firm. Solution: APES 110: 290.107 If a member of the Assurance Team, or their Immediate Family member receives, by way of, for example, an inheritance, gift or, as a result of a merger, a Direct Financial Interest or a material Indirect Financial Interest in the Assurance Client, a self-interest threat would be created. The following safeguards should be applied to eliminate the threat or reduce it to an acceptable level: a) Disposing of the Financial Interest at the earliest practical date; or b) Removing the member of the Assurance Team from the Assurance Engagement. During the period prior to disposal of the Financial Interest or the removal of the individual from the Assurance Team, consideration should be given to whether additional safeguards are necessary to reduce the threat to an acceptable level. Such safeguards might include: • •

Discussing the matter with those charged with governance, such as the audit committee; or Involving an additional professional accountant to review the work done, or otherwise advise as necessary.

Kerry was not a shareholder in his client Darcy Industries Ltd, but is at risk of becoming a shareholder in a member of the group if Darcy's takeover of Blacklight is successful. Kerry would normally be regarded as an indirect shareholder rather than a direct shareholder because the shares are held by his self-managed superannuation fund (SMSF). A SMSF is a trust arrangement where Kerry cannot directly deal with the shares and will only benefit on his retirement (or his estate will benefit on his death). However, APES 110, s. 290.103 deems the financial interest to be direct if the beneficial owner has control over the investment vehicle. Kerry is aware of the investment of his SMSF in Blacklight if he is a director of the fund (which he would almost certainly be as it is 'his' fund according to the question). There is a potential for Kerry's decision making to be affected because an 3

ACCT3322 SEMESTER 2, 2018 increase in value of the shares would indirectly benefit him. He should take steps to dispose of the shares if it is likely that the takeover bid will be successful, if he has control over the investment vehicle. If he does not have control over the investment vehicle, he should still dispose of the shares if the interest is material. (see 290.104)

Question: Evaluation of ethical issues Harry and Andrew are two audit seniors working for ABC Associates, a large audit firm. Harry is married with a young child and a large mortgage. Andrew is single and still lives with his parents. They have both been seniors for two years and are looking for promotion to audit supervisor, but both are aware that there is only one supervisor position available. Harry recently replaced Andrew on the audit of Claremont Ltd, and the reason given to both Harry and Andrew was that another assignment had arisen with one of Andrew’s other long-time clients. Once Harry had replaced Andrew on the Claremont Ltd audit, he realised that the accountant of Claremont Ltd had called the audit manager to say that they were not impressed with Andrew, as he had missed a number of issues within the audit and was arriving at work late. The audit manager had not discussed these comments with either Harry or Andrew. After going through the work that Andrew had completed, Harry realised that Andrew had performed an excellent job, identifying a number of issues that he thought he might possibly have missed. Furthermore, Harry suspects that Andrew and the accountant had a personality conflict, and that the accountant has misled the audit manager. Harry realises that he can finish off the audit, resolve the issues and obtain a good review from this assignment, which would help him in the promotion stakes. He also knows that the audit manager is unlikely to bring the client’s unsupported allegations to Andrew’s attention. Required: Using the steps involved in ethical conflict resolution, identify and discuss the ethical issues involved and describe what action you should take. The steps to resolve ethical dilemma are: 1. 2. 3. 4. 5. 6.

Lay down the relevant facts, Identify the ethical issues involved, Identify the fundamental principles being threatened, Identify the alternative courses of action available to you, Compare and assess the alternatives (lay down the pros and the consequences), Decide [Adapted from Gay and Simnett (6e), Auditing and Assurance Services in Australia, Mc Graw Hill.

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ACCT3322 SEMESTER 2, 2018 Solution: 1. Determine the facts Harry and Andrew are both audit seniors working for the same large audit firm. The client made comments to the audit manager about Andrew, but the audit manager didn’t discuss these comments with either Andrew or Harry. Harry has now replaced Andrew. 2. Determine the ethical issue Should Harry act honestly and fairly by discussing his suspicions that Andrew was treated unfairly by the audit client with the audit manager and partner, or should he remain silent and potentially improve his career? 3. Identify the major principles being threatened See APES 110 (sec.100–150) • Integrity—auditors should be straightforward, honest and sincere in their approach to professional work. • Objectivity—auditors must be fair and not allow prejudice or bias to override their objectivity. 4. Specify the alternatives • Harry can do nothing. • Harry can inform the audit manager of the suspected personality conflict and the good work that Andrew has done on the assignment. • Harry can discuss the situation with Andrew and inform him that he might have been misjudged by the audit manager and partners. 5. Compare values and alternatives If Harry does nothing, he would not honour the major principles of integrity and honesty. However, if he does report to Andrew or the audit manager, then there is a risk that he will not be promoted, thereby affecting his family’s financial security. If Harry does nothing, • Harry might gain a promotion over Andrew. • Harry fails to uphold his ethical principles of integrity and objectivity. • Andrew might be unfairly treated by the audit manager and partnership. • The manager or partners might subsequently discover that Harry took credit for work that Andrew performed. • Subsequently, Harry’s honesty and integrity might be questioned. If Harry informs the audit manager of suspicions, • Harry upholds his principles of integrity and objectivity. • Andrew might receive credit for the good work and gain a promotion instead of Harry. • Andrew might gain a promotion ahead of Harry now, but Harry might be well regarded for his integrity and objectivity and improve his chances for future promotion.

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ACCT3322 SEMESTER 2, 2018 If Harry discusses the situation with Andrew • Consequences are the same as for informing the audit manager (assuming that Andrew acts on the information to clear up any misunderstanding). 6. Make your decision Either informing the audit manager of his suspicions or discussing the situation with Andrew would appear to be appropriate solutions.

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