Chapter 5 client acceptance

HKSQC 1 “Quality control for firms that perform audits and reviews of historical financial information, and other assurance and related services engagements”
26The firm shall establish policies and procedures for the acceptance and continuance of client relationships and specific engagements, designed to provide the firm with reasonable assurance
that it will only undertake or continue relationships and engagements where the firm:(a)Is competent to perform the engagement and has the capabilities, including time and resources, to do
so; (b)Can comply with relevant ethical requirements; and(c)Has considered the integrity of the client, and does not have information that would lead it to conclude that the client lacks integrity.
27Such policies and procedures shall require: (a)The firm to obtain such information as it considers necessary in the circumstances before accepting an engagement with a new client, when
deciding whether to continue an existing engagement, and when considering acceptance of a new engagement with an existing client. (b)If a potential conflict of interest is identified in
accepting an engagement from a new or an existing client, the firm to determine whether it is appropriate to accept the engagement. (c)If issues have been identified, and the firm decides to
accept or continue the client relationship or a specific engagement, the firm to document how the issues were resolved. A18Consideration of whether the firm has the competence, capabilities,
and resources to undertake a new engagement from a new or an existing client involves reviewing the specific requirements of the engagement and the existing partner and staff profiles at all
relevant levels, and including whether:(1)Firm personnel have knowledge of relevant industries or subject matters(2)Firm personnel have experience with relevant regulatory or reporting
requirements, or the ability to gain the necessary skills and knowledge effectively(3)The firm has sufficient personnel with the necessary competence and capabilities(4)Experts are available,
if needed;(5)Individuals meeting the criteria and eligibility requirements to perform engagement quality control review are available, where applicable; and.(6)The firm is able to complete the
engagement within the reporting deadline. A19 With regard to the integrity of a client, matters to consider include, for example:(1)The identity and business reputation of the client's principal
owners, key management, and those charged with its governance.(2)The nature of the client's operations, including its business practices.(3)Information concerning the attitude of the client's
principal owners, key management and those charged with its governance towards such matters as aggressive interpretation of accounting standards and the internal control
environment.(4)Whether the client is aggressively concerned with maintaining the firm's fees as low as possible. (5)Indications of an inappropriate limitation in the scope of work. (6)Indications
that the client might be involved in money laundering or other criminal activities. (7)The reasons for the proposed appointment of the firm and non-reappointment of the previous firm. (8)The
identity and business reputation of related parties. A20 Sources of information on such matters obtained by the firm may include the following:(1)Communications with existing or previous
providers of professional accountancy services to the client in accordance with relevant ethical requirements, and discussions with other third parties. (2)Inquiry of other firm personnel or third
parties such as bankers, legal counsel and industry peers. (3)Background searches of relevant databases.
HKSA 220 “quality control of audits of financial statements”12 The engagement partner shall be satisfied that appropriate procedures regarding the acceptance and continuance of client
relationships and audit engagements have been followed, and shall determine that conclusions reached in this regard are appropriate.
210.1 Before accepting a new client relationship, a professional accountant in public practice shall determine whether acceptance would create any threats to compliance with the fundamental
principles. Potential threats to integrity or professional behavior may be created from, for example, questionable issues associated with the client (its owners, management or activities).
440 “changes in a professional appointment” 440.1 Where a change of auditor is contemplated, the nominated auditor should write to the existing auditor to obtain “professional clearance”.
This is an important procedure to be followed to protect the interest of the nominated auditor, such that he may be made aware of any unusual circumstances surrounding the proposed change
of auditor which may be relevant in determining his acceptance of nomination. 440.3 A member who is asked to accept nomination as auditor should (a)find out whether the change of auditor
has been properly dealt with in accordance with the Companies Ordinance or other legislation; and (b)request the prospective client’s permission to communicate with the auditor last appointed.
440.5 A member should decline nomination if the prospective client (a)fails to properly deal with the change of auditor in accordance with the Companies Ordinance or other legislation; or
(b)refuses permission for him to communicate with the auditor last appointed. 440.6 On receipt of permission to communicate with the auditor last appointed, a member should request in
writing of the latter if there are any unusual circumstances surrounding the proposed change which he should be aware of, so that he may determine whether he should accept nomination.
440.7 A member receiving such written request should act expeditiously and:(a)if there is no professional or other reason why the proposed nominee should not accept nomination, reply
accordingly without delay; or (b) if he considers it appropriate to discuss the client’s affairs with the proposed nominee, request permission of the client to do so freely. If this request is not
granted the member should report that fact to the proposed nominee who should not accept nomination. 440.8 On receipt of permission from the client, the member should advise the proposed
nominee of his concern about the circumstances surrounding the proposed change and disclose fully all information needed by the proposed nominee to enable him to decide whether to accept
nomination.
441 “Change of auditors of a listed issuer of the stock exchange of Hong Kong” 441.10 This section requires the outgoing auditors to prepare a letter to the audit committee and the board of
directors of the listed issuer, whenever:(a)the outgoing auditors resign or decline to stand for re-appointment (Resignation); or (b)the listed issuer decides to propose to its shareholders that the
outgoing auditors be removed from office during the auditors’ term of office, or there is a proposal or intention not to re-appoint them on the expiry of their term of office (Termination). 441.11
The outgoing auditors’ letter to the audit committee and the board of directors should set out the circumstances leading to their Resignation or Termination, hereafter referred to as “Letter of
Resignation or Termination”. The circumstances to be disclosed in the Letter of Resignation or Termination are all occurrences that, in the opinion of the outgoing auditors, affect the relationship
between the listed issuer and the outgoing auditors. 441.12 Occurrences that affect the relationship between the listed issuer and the outgoing auditors include, but are not limited to,
“disagreements” and/or “unresolved issues”, as discussed below. The disagreements and unresolved issues to be disclosed will generally be those that occurred in connection with:(a)the audit
of the listed issuer’s most recently completed financial year;(b)any period subsequent to the most recently completed financial period for which an audit report has been issued up to the date
of the Resignation or Termination.
441.18 Since the outgoing auditors are required to disclose the circumstances leading to their Resignation or Termination in the Letter of Resignation or Termination, the incoming auditors
should request a copy of the Letter of Resignation or Termination and any correspondence referred to in the letter directly from the listed issuer for consideration in addition to requesting
professional clearance from the outgoing auditors before accepting the appointment. 441.19 If the listed issuer refuses to provide the incoming auditors with a copy of the Letter of Resignation
or Termination and any correspondence referred to in the Letter of Resignation or Termination, the incoming auditors should decline to accept nomination.

Chapter 6 (audit risk – inherent risk)

Receivable: 1)release provision: receivable overvalued. Some balances will be irrecoverable. Extended post year-end cash receipts testing and a review of the aged receivables ledger to
performed to assess valuation and the need for an allowance for receivables. 2)increase receivable: there is risk that some receivable be overvalued as they are not recoverable. Same control
as above. Also there would be receivable that not actually exist. External confirmation of receivables to confirm that customers exist and represent valid amounts due.
Inventory: 1)Inventory count: it is unlikely that the auditor will be able to attend all inventory counts and therefore they need to ensure that they obtain sufficient evidence over the inventory
counting controls, and completeness and existence of inventory for any warehouses not visited. The auditor should assess which of the inventory sites they will attend the counts for. This will
be any with material inventory or which have a history of significant errors. For those not visited, the auditor will need to review the level of exceptions noted during the count and discuss
with management any issues which arose during the count. 2)valuation method: inventory should be valued at the lower of cost and net releasable value(NRV) and if this is not the case, then
inventory could be under or overstated. Testing should be undertaken to confirm cost and NRV of inventory and that on a line-by-line basis the goods are valued correctly. Other method is
applicable as long as it is a close approximation to cost. If this is not the case, then inventory could be under or overvalued. In addition, valuation testing should focus on comparing the cost
of inventory to the selling price less margin to confirm whether this method is actually a close approximation to cost. 3)damaged: inventory should be at the lower of cost and NRV. It is likely
that inventory overvalued. Detailed cost and net realizable value testing to be performed to assess how much the inventory requires writing down by.
PPE: 1)refurbishment: if the expenditure is of a capital nature, it should be capitalized as part of PPE. If it relates more to repairs, it should be expensed to the income statement. If the
expenditure is not correctly classified, profit and PPE could be under or overstated. The auditor should review a breakdown of these costs to ascertain the split of capital and revenue expenditure,
and further testing should be undertaken to ensure that the classification in the financial statements is correct. 2)disposed: the asset needs to have been correctly removed form PPE to ensure
the non-current asset is not overstated, and the profit on disposal should be included in the income statement. Auditor should review the non-current asset to ensure that the asset has been
removed. Also confirm the disposal proceeds as well as recalculating the profit on disposal. Consideration should be given as to whether the profit on disposal is significant enough to warrant
separate disclosure within the income statement. 3)rent: only warehouses owned by company should be included within PPE. PPE could be overstated and rent expense be understated. The
auditor should review supporting documentation for all warehouses to confirm the ownership by company and ensure accounts are not overstated.
Payable: 1)loan: loan needs to be correctly split between current and non-current liabilities. Auditor need to confirm the loan finance was received. In addition, the split between current and
non-current liabilities and the disclosures for this loan should be reviewed in detail to ensure compliance with relevant accounting standards. 2)charge: company may give the bank a charge
over its assets as security for the loan. There is a risk that the disclosure of any security given is not complete. The loan agreement should be reviewed to ascertain whether any security has
been given, and this bank should be circularized as part of the bank confirmation process.
Revenue: 1)complaint and refund: revenue is possibly overstated if sales returns are not completely and accurately recorded. Review the breakdown of sales of damaged goods, and ensure that
they have been accurately removed from revenue.
Expense: 1)R&D: research cost be expensed and development costs to be intangible asset. Risk of intangible asset be overstated, and expenses understated. Auditor obtain a breakdown of the
expenditure and undertake testing to determine whether the costs relate to the research or development state. Discuss the accounting treatment with the finance director. 2) wage: a sales-related
bonus scheme would lead to sales cut-off errors with employees aiming to maximize their current year bonus. Increases sales cut-off testing will be performed along with a review of any post
year-end cancellations of contracts as they may indicate cut-off errors.
Accouring system: 1)New system: the auditor should undertake detained testing to confirm that all opening balances have been correctly recorded in the new general ledger system. There is
risk of opening balances being misstated and loss of data if they have not been transferred form the old system correctly. In addition, the new system will require documenting and the controls
over this will need to be tested. They should document and test the new system. They should review any management reports run comparing the old and new system during the parallel run to
identify any issues with the processing of accounting information. 2)headquarter issues: there is risk that transfer has not been performed completely and accurately, the opening balances may
not be correct. Discuss with management the process undertaken to transfer the data and the testing performed to confirm the transfer was complete and accurate. Computer-assisted audit
techniques could be utilized by the team to sample test the transfer of data form each division to head office to identify any errors.
Manager: 1)payroll: risk to overstate the assets through the judgment taken or the use of releasing provisions. Throughout the audit the team will needed to be alert to this risk. They will need
to maintain professional skepticism and carefully review judgmental decisions and compare treatment against prior years. Disclosure not complete. Discuss the disclosure to see compliance
with local legislation 2)leaving: auditor should remain alert throughout the audit for additional errors within the finance department. The increases the inherent risk within company as errors
may have been made within the accounting records by the overworked finance team members. The new financial controller may not be sufficiently experienced to produce the financial
statements and resolve any audit issues. In addition, discuss with the finance director whether he will be able to provide the team with assistance for any audit issues the new financial controller
is unable to resolve.
Other: 1)New customer: there will be increased detection risk on the audit. Audit firm ensure they have a suitably experienced team. Also, adequate time should be allocated for team members
to obtain an understanding of the company and the risks of material misstatement.
Chapter 7 (control risk – deficiencies & assess the risk of material misstatements at financial statement level)
The risk of material misstatement at the financial statement level refers to risks of material misstatement that relate pervasively to the financial statements as a whole and potentially affect
many assertions
Risks of material misstatement at the financial statement level often relate to the entity’s control environment.
[The control environment of company includes: (1)its governance and management functions; and (2)the attitudes, awareness, and actions of company’s directors, and the management
concerning company’s internal control and its importance.]
The nature of the risks arising form a weak control environment is such that the risks are not likely to be confined to specific individual risks of material misstatement in particular classes of
transactions, account balances, and disclosures.
In addition to a weak control environment, other conditions may also lead to higher risks of misstatement at the financial statement level. Such conditions may include aggressive business
strategies, significant business risks arising from changes or complexity of business operations, and unusually high pressures on performance measures and review.
On the basis of the factors discussed above, risk of material misstatement at the financial statement level for the financial statements of company for the year is assessed as medium or (high)

Chapter 8 risk response – sales & account receivables

Sales: (1)revenue significantly increased (%) form the prior year and there was no significant capital investment in PPE to increase the production capacity. (2) the gross profit margin increase
form (%) to (%). For manufacturing company, revenue should change in line with cost of goods sold. (3)the accounts receivable balance increased to (no.) times of the same in the last year
and the debtor turnover period(accounts receivable/revenue*365) increased from (no) to (no). it indicated that the revenue may be overstated by including non-exist debtors.
Occurrence: (1)perform a financial analysis of fluctuation of gross profit margin. (2)ask the management for the reasons for the fluctuation in gross profit margin with reference to the market
situation. (3)perform and industry comparison and analysis to document whether the change in gross profit margin is in agreement with the current market tends and situation. (4) perform a
walk through test and control test to ensure the effectiveness of internal controls implemented for the revenue cycle. (5)review whether the entity is following HKAS 18 revenue and applies
the revenue recognition policies consistently throughout the periods (6) discuss with the staff at the operational level to ensure an understanding that the business operation procedure was
correct and up to date and there are no key changes in the business operation procedure. (9) perform substantive procedures by selecting samples from the sales ledger and tracing them in
goods delivery documents to ensure proper recording (10)direct confirmation of customers to confirm the total sales amount for the year.
General revenue: (1)Compare the overall level of revenue against prior years and budgets and investigate any significant fluctuations. (2)Obtain a schedule of sales for the year broken down
into the main product categories and compare this to the prior year breakdown and for any unusual movements discuss with management. (3)Calculate the gross profit margin for Heraklion
Co and compare this to the prior year and investigate any significant fluctuations. (4)Select a sample of sales invoices for customers and agree the sales prices back to the price list or customer
master data information to ensure the accuracy of invoices. (5)Select a sample of credit notes raised, trace through to the original invoice and ensure the invoice has been correctly removed
from sales. (6)Select a sample of customer orders and agree these to the despatch notes and sales invoices through to inclusion in the sales ledger and revenue general ledger accounts to ensure
completeness of revenue. (7)Select a sample of despatch notes both pre and post year end and follow these through to sales invoices in the correct accounting period to ensure that cut-off has
been correctly applied.
Account receivable: Trade receivables amount should be the outstanding amount on trade receivables less impairment loss for irrecoverable debt Audit procedures on sales and trade receivables
are usually combined due to the inter-relationship between the two items in accounting procedures and internal control systems. Auditor should understand and evaluate the major activities
that company uses to monitor internal control over financial reporting which, in this case, include the design and operating effectiveness of the accounting procedures and internal controls
relating to sales and trade receivables. These accounting procedures and internal controls should cover: (1)billing procedures and recordings of sales and receivables, (2)quality assurance/control
procedures over products before and after delivery, (3) credit policies and controls, (4) collection of trade receivables, (5) procedures adopted by company’s management in the identification
and estimate of impairment loss for irrecoverable debt.
Accuracy, valuation and allocation: (1)Review the after date cash receipts and follow through to pre year-end receivable balances. (2)Inspect the aged receivables report to identify any slow
moving balances, discuss these with the credit control manager to assess whether an allowance or write down is necessary. (3)For any slow moving/aged balances review customer
correspondence to assess whether there are any invoices in dispute. (4)Review board minutes of Dashing Co to assess whether there are any material disputed receivables. (5)send a confirmation
to debtors (6) compare the balance to the relevant turnover and previous periods (7)compare the aged analysis to other debtors and previous periods (8)discuss with management the nature and
status of the dispute(if exist) (8) discuss with the management the recoverability (9)discuss with management the implications of debtor’s claims on other debtors or accounts (10)check for
any subsequent settlement from debtor and other long outstanding debtors; (11)check for any returns of goods from C limited and other customers.
Completeness: (1)Select a sample of goods despatched notes from before the year end, agree to sales invoices and to inclusion in the sales ledger and year-end receivables ledger. (2)Agree the
total of individual sales ledger accounts to the aged receivables listing and to the trial balance. (3)Obtain the prior year aged receivables listing and for significant balances compare to the
current year receivables listing for inclusion and amount due. Discuss with management any missing receivables or significantly lower balances. (4)Review the sales ledger for any credit
balances and discuss with management whether these should be reclassified as payables.

Chapter 9
Going concern: Under HKSA570 Going concern, Company’s auditor shall obtain sufficient appropriate audit evidence about the appropriateness of company management’s use of the going
concern assumption in the preparation of the financial statements and conclude whether there is a material uncertainty about company’s ability to continue as a going concern.
Going concern: (1)appropriate (2)inappropriate (3)appropriate with material uncertainty → management should disclose in the note. (1)properly disclosed: unqualified opinion (2)No disclosed:
qualified opinion.
Subsequent events: the settlement was a subsequent event, and to be more specific, it was an event occurring between the date of financial statements and the date of auditor’s report (after
auditor’s report) In accordance with HKSA560, the engagement team should perform procedures designed to obtain sufficient appropriate audit evidence that all events up to the date of the
auditor’s report that may require adjustment of , or disclosure in, the financial statements have been identified. Such procedure ordinary include the following: (1)Reviewing procedures the
management has established to ensure that subsequent events are identified. For example, the engagement may consider whether the management of company would be alerted of significant
(change) subsequent to the financial year end. If company has such procedures properly in place, it is likely that the management could identify the settlement on a timey basis. (2)Reading
minutes of the meetings of shareholders, the board of directors and audit and executive committees held after the date of the financial statements and inquiring about matters discussed at the
meetings for which minutes are not yet available. Given that such meetings would not be frequent, it is unlikely that these procedures would identify the settlement. (3)Read company’s latest
available interim financial statements and, as considered necessary and appropriate, budgets, cashflow forecasts and other related management reports. Given that the preparation of such
statements and reports would not be frequent, it is unlikely that these procedures would identify the settlement. (4)Inquiring, or extending previous oral or written inquires, of SMC’s lawyers
concerning litigation and claims. Unless the lawyers of company have been involved in dealing with the customer for settlement, such an inquiry or extended confirmation is unlikely to identify
the settlement. (5)Inquiring of management of SMC as to whether any subsequent events have occurred which might affect the financial statements. (6)provided that company has an effective
and efficient internal system in identifying and reporting significant/major cash movements, it is very likely that the engagement team’s inquiry of management would identify the settlement.
Subsequent events: (1)adjusting event: prepare adjusting journal entry (2)Non-adjusting event: disclose in notes (3)before audit report: active responsibility, auditors request company to amed
financial statements. If the management of company refuse to amend the financial statement, the engagement team should consider whether it is appropriate to issue a qualified opinion in
accordance with HKSA701 (4)after audit report: passive responsibility, management disclose issues, auditors amend report or withdraw opinion.