HI-6026

Question 1

Question 1a.

An audit is conducted through examination of materials supplied to the company regarding its
internal reporting mechanisms, and financial statements; and a CPA is required to make a
selection amongst the available materials using professional judgment 1. The concept of
reasonable assurance states that the auditor can provide a high but not absolute level of assurance
that the materials examined supplied by the company – statements, protocols, etc. are free from
undetected misstatements, fraud, concealment or error2.

In other words, the concept of reasonable assurance legitimizes that absolute assurance cannot be
obtained in an audit as a principle. Here are some of the factors why only a high but absolute
assurance cannot be obtained:

The nature of financial reporting and accounting is complex, and in a corporate context can result
in deliberate or inadvertent mis-categorization of elements, or mis-categorization purely due to
subjective understanding of complex protocols which may affect the bottom line.

The function of auditing is ensure that the internal protocols of the company are efficiently and
would be capable of producing the projected results of the company. An audit can provide a
professional opinion, based on skilled judgment, and is thus by its nature not absolute.

The time and cost constraints of the audit inherently limits scope of absolute certainty, as it
forces the audit to make a selection on available materials, which only achieves a high but not
absolute probability that the materials not examined are not free from significant errors or
misreporting.

1
O. Ray Whittington and Kurt Pany, Principles Of Auditing & Other Assurance Services (McGraw-Hill Education,
20th ed, 2016) 3.
2
Ibid, 38.
Nefarious factors such as collusion between employees and management for fraudulent purpose
may be at play fall outside the scope of the materials provided for examination to the auditor.

Question 1b.

The function of auditor is examination and inspection – trying to find cracks – in the company’s
statements and processes. The very nature of the function requires the auditor to stay on tows.
The concept of the professional skepticism requires that the auditor to have a “questioning
mind”3 that remain alert to the possibility or unintentional errors or intentional misstatements by
officers of the company. To this end, the auditor must remain alert of evidence which contradicts
other evidence examined4. The attitude of professional skepticism for auditors cannot be
overemphasized as it influences an auditor’s ability to exercise professional judgment and react
if he is confronted by materials which he suspects to be misreported5.

The concept of professional skepticism must be practiced by auditors at all times as a matter of
mandatory protocol, regardless of the auditor’s subjective view of the management’s honestly.
Hence the auditor does not presume that the management is trying to deceive them in a party
case, or does he relax the strictness of the audit based on his personal opinion.

3
ASA 200 Overall Objectives of the Independent Auditor and the Conduct of an Audit in Accordance with
Australian Auditing Standards, paragraph 13(l).
4
Auditing and Assurance Standards Board, Professional Scepticism In An Audit Of A Financial Report (Australian
government, 2012) 1.
5
Ibid.
 Question 2

Question 2a.

The ethical considerations for auditors is governed by the APES 110 Code of Ethics for
Professional Accountants (including Independence Standards). There are some potential ethical
concerns and violations of the APES 110 Code in this situation.

APES 511.1 requires auditor firms to comply with the fundamental principles of the APES 110.
It is required under APES 110, 120.2, that auditors identity, evaluate, and attempt to address any
threats of violations to APES 110.

AES 110, 120.6 A3 (a) identifies self-interest as a threat to the compliance of the auditor with the
fundamental principles of APES, and defines self-interest as a financial or other interest that will
have the effect of influencing an auditors judgment.

APES 110, 410.7 A1 A establishes that there is a general expectation that an auditor would be
paid before releasing the audit report.

As per APES 110, 410.7 A1 A and APES 110, 511.2 if a significant portion of the fees remain
outstanding for service previously given, then it might amount to self-interest for the auditor.

As per APES 110, R410.8, significant fees remaining overdue for long time from an audit client
may be considered a loan by the audit firm.

APES R511.4 (a) prohibits auditor firms from giving loans to audit client unless the loan is
immaterial to the firm.

Therefore the situation potentially create ethical problems of self-interest and the unpaid fees
amounting to an unsanctioned loan to the auditor client that violates APES 110.

Question 2b.

APES 110, R410.8 allows the firm to consider the unpaid fees as an outstanding loan to the audit
client and terminate their engagement with the audit client. As regards to the concern that the
audit report was practically completed and needed only signatures, similar cases in Canada as
reported by McLennan Ross LLP on Mondaq 6 has found auditors not at fault for refusing to
release audit reports in similar circumstances.

Therefore it is advised that the firm withholds the report, severs their employment with
Broomers Pty Ltd and negotiates for the repayment of the loan, perhaps in exchange for the audit
report, or if that is not possible file a suit for the recovery of the loan.

6
Graham McLennan and Clarissa Dhillon, "Auditor Independence And Unpaid Fees - Accounting And Audit -
Canada", Mondaq.Com (Webpage, 2020) <https://www.mondaq.com/canada/audit/541862/auditor-independence-
and-unpaid-fees>.
 Question 3

Question 3a.

It is the job of the auditor to render judgment regarding material deficiencies in a company’s
statements or issues regarding the company’s affairs. What is material may be classified as that
which has the ability to influence the relevant financial decisions of a party who relies on the
financial statements audited7. The auditor has to determine and apply an appropriateness of
materiality to all incoming information examines as a function of performing the audit8.

What is to be classified as material would depends on the professional judgment of the auditor
considering that materiality depends both on quantitative and qualitative concerns.

Even where materiality depends on quantitative concerns there are no established thresholds as
to transactions of what value should be considered material. It would for instance depend on the
size of the transaction - whereas an issue involving $1000 might be considered material for a
condominium property owner’s association, for IBM it could be require $10 million9.

On the other hand, a situation which would demonstrate the qualitative concerns regarding
materiality could be, a related party transaction where the company sells an asset to a member of
top management and buys it back at a higher price. Even if a substantial amount of money was
not involved, the nature of the transaction itself invites materiality concerns.

Question 3b.

The facts state the restaurant business client of MMM Chartered Account are facing severe cash
flow problems in their business which has forced them to pay suppliers late consistently well in
excess of the normal credit terms between a customer and supplier. As a result, the suppliers
have now stopped extending a line of credit to the restaurant business and are demanding that
cash in exchange for goods. This is a severe problem for a restaurant business as the nature of the
business is such that goods are perishable and have to refilled often – the industry is heavily

7
Above 1, 46.
8
Ibid, 38.
9
Ibid, 46.
dependent on raw materials, and thus without a cash flow, which the business does not have, it
will be unable to get regular supply of raw materials, and will face a major impediment to their
operations.

Underlying situations like this present which present a stressful time for a business are generally
classified as high risk situations for both inherent and control risk for auditing purposes as these
situations force management to outright falsify accounts or overestimate their earnings
projections to raise more money through loans or investments.

A degree of materiality is quantitative amount beyond which transactions having misstatements

will be considered as financially material or consequential. The threshold level of materiality has
to be determined according to factors like the financial health of the company. A bad financial
health raises the risk of misstatements by the management and thus requires a lower threshold of
materiality to ensure that misstatements of a lower value are not classified as immaterial since it
would matter now that the company is facing cash problems.

Therefore the present situation at the restaurant would lead to a decrease in the level of
preliminary materiality in the auditor’s assessment.
 Question 4

Question 4a.

As per ASA 570, the meaning of a going concern assumption is that while financial statements
are prepared for a company, it is generally assumed that the company will continue to be in
business as a going concern for the foreseeable future, as the recoding to assets and liable are
done in a manner that they will be realized or discharged (respectively) within the normal course
of the business. An auditor has to apply a subjective decision making after reviewing the
financial document to give a professional opinion as to whether it would be appropriate to
classify a company as a going concern or not.

As per ASA 570.10, it is required that an auditor evaluates the question of whether the company
is a going concern at the planning and procedure stage of the audit itself, and not only as a
consideration for the final report, as a business facing an imminent threat make prompt
misstatements from the management which will affect the final audit report.

Some indications against the assumption of going concerns are as follows –

 If the management has taken a decision to cease operations.

 If liabilities are in excess of assets.
 If fixed assets are being acquired through continuous short term borrowings.
 If the company has recently lost key management personnel.
 If the company has sufferance a major loss, or has lost a major license or franchise.
 If the company has been going through prolonged litigation.
 If the company or the industry is facing a shortage of key raw materials.
 If the company is facing major competition.
 If the company has suffered a loss from a major uninsured disaster.
 If some major legislative changes adversely affects the company.
 A decease in indices like liquidity radios, margins, ROI, debt to equity ratio.
Question 4b.

The following events and facts are identified as casting significant doubts on SS’s ability to
persist as a going concern –

a) The fact that SS has paid its suppliers late well in excess of supplier’s agreed limits from
30th January onwards casts aspersions on SS’s ability to remain a going concern till the
end of 2018 , or more importantly in the foreseeable future of 2019 or 2020. The question
is not just limited to a particular supplier, as late payments to this extent can potentially
blacklist SS from other supplier’s in the area also, who can outright refuse to supply SS
or supply only on the basis of cash on delivery, both of which will affect SS’s business
quite badly.
b) The fact that suppliers are demanding cash for goods from SS, refusing to extend the line
of credit any further, coupled with the fact that SS is facing cash flow problems would
mean SS would be or is already facing a short of supplies. This is particularly bad for
going concern assumptions in the restaurant industry as regular or daily supply of raw
materials is very important. Even if SS manages to financially recover later, a period of
raw material shortage can lead to a loss of reputation and customers in the market, which
can lead to long term adverse consequences.
c) The fact that SS has been facing cash flow problems for a long time from 2016 also
means that there is a problem with management as they are unable to solve this issue for
a long time. Ineffective management is also a threat to the assumption of going concern.
 QUESTION 5

Client Accounting Treatment Justification

5a) Caulfield Adjusting event The event should be
classified as an adjusting
event since responsibility for
the shipment was transfer to
Caufield in November 2017
already which was the FOB
shipping point.

Audit procedure that should

have brought the item to the
auditor’s attention is review
of interim accounts.
5b) Caufield Non-adjusting event The event should be
classified as a non-adjusting
as the company not
previously recorded a liability
for the claim and all financial
repercussions occurred after
the balancing date.

Audit procedure that should

have brought the item to the
auditor’s attention is
obtaining a letter from the
company’s lawyer about
ongoing disputes against the
company.
5c) Caulfield Non-adjusting event The event should be
classified as a non-adjusting
as no payment was earmarked
in 2017, and the company’s
sales would also increase
only in the future.

Audit procedure that should

have brought the item to the
auditor’s attention is a study
of the minutes of the meeting
of the board and members to
find a resolution authorizing
the transaction.
5c) Caufield Non-adjusting event The event should be
classified as a non-adjusting
as the loss occurred after the
balancing date, and no
repercussions were felt
before.

Audit procedure that should

have brought the item to the
auditor’s attention is
discussion with directors and
staff of the company.
 QUESTION 6

Client Auditor Opinion Justification

Event 1 Disclaimer of Opinion A disclaimer of opinion
Steel Limited would in this case be the most
appropriate, as recent
governmental changes
prevents the auditor from
verifying key accounts of
inventory, fixed assets and
cash and related income
statement balances. Therefore,
it is not possible for the auditor
to ascertain whether
undetected misstatements
would be material or
pervasive.
Event 2 Unmodified Opinion An unmodified opinion
Surf Limited would be appropriate in this
case, because as per the facts
stated, that the transactions in
question would be immaterial
and irrelevant to people
utilizing the financial report.
Event 3 Adverse Opinion An adverse opinion would be
Ranger Limited the most appropriate in this
case as the misstatements in
this situation would not only
be material but also pervasive
because the figures and
graphs in question concern
the total revenue of the
company and not just revenue
from one transaction.
Event 4 Qualified Opinion A qualified opinion would be
Minco Limited the most appropriate in this
case, as potential
misstatements due change in
depreciation period would
materially affect the financial
statements, but since it is
restricted to machines which
only forms part of the
statement consisting of other
parts, it cannot be said to be
pervasive.
 List of legislation

Auditing Standard ASA 570 Going Concern

APES 110 Code of Ethics for Professional Accountants (including Independence Standards)

ASA 200 Overall Objectives of the Independent Auditor and the Conduct of an Audit in
Accordance with Australian Auditing Standards

Bibliography

Auditing and Assurance Standards Board, Professional Scepticism In An Audit Of A Financial

Report (Australian government, 2012).

McLennan, Graham and Clarissa Dhillon, "Auditor Independence And Unpaid Fees -
Accounting And Audit - Canada", Mondaq.Com (Webpage, 2020)
<https://www.mondaq.com/canada/audit/541862/auditor-independence-and-unpaid-fees>

Whittington, O. Ray and Kurt Pany, Principles Of Auditing & Other Assurance

Services (McGraw-Hill Education, 20th ed, 2016).