SECTION A

11. Impact of outsourcing on the audit

Outsourcing does have an impact on audit planning. ISA 402 requires the auditor to obtain an
understanding of how the audited entity uses the services of a service organisation in the user entity’s
operations, including the following matters:

 The nature of the services provided by the service organisation and the significance of those services
to the audited entity, including the effect on internal control

 The nature and materiality of the transactions processed or accounts or financial reporting processes
affecte d by the service organization

 The degree of interaction between the activities of the service organisation and those of the audited
entity

 The nature of the relationship between the audited entity and the service organisation, including the
relevant contractual terms.

Required under ISA 402 to evaluate the design and implementation of relevant controls at the audited
entity which relate to the services provided by the service organisation, including those which are
applied to the transactions processed by the service organisation. This is to obtain understanding of the
control risk associated with the outsourced function.

It is common for a report on the description and design of controls at a service organisation to be
obtained. A type 1 report focuses on the description and design of controls, whereas a type 2 report also
covers the operating effectiveness of the controls. This type of report can provide some assurance over
the controls which should have operated at the service organisation.

Alternatively, the auditor may decide to contact the service organisation to request specific information,
to visit the service organisation and perform procedures, probably tests on controls.

The purpose of obtaining the understanding above is to help the auditor to determine the level of
competence of the service organisation, and whether it is independent of the audited entity. This will
then impact on the risk of material misstatement assessed for the outsourced function.

Audit manager joining client

The familiarity threat is caused by the relationship that Bob Halen will have with the audit team, having
worked at the firm. This may cause the audit team to fail to challenge him sufficiently and lose
professional scepticism.

The more junior members of the audit team may also feel intimidated by him as his previous position
was as audit manager. He will also be aware of the firm’s audit methodology and procedures, making it
easier for him to circumvent procedures.

If a former member of the audit team or partner of the firm has joined the audit client in a position that
can influence the preparation of the financial statements, and a significant connection remains between
the firm and the individual, the threat would be so significant that no safeguards could reduce the threat
to an acceptable level.

It is crucial that Foo & Co ensures that no significant connection between the audit firm and Bob Halen
remains.

Foo & Co should have in place policies and procedures which require members of an audit team to
notify the audit firm when entering employment negotiations with the client.

Contingent fee
This is not allowed according to IESBA’s International Code of Ethics for Professional Accountants.
Contingent fee arrangements in respect of audit engagements create self‐interest threats to the
auditor’s objectivity and independence that are so significant that they cannot be eliminated or reduced
to an acceptable level by the application of any safeguards. If the fee is contingent on the company’s
performance the audit firm may not request management to make adjustments to the financial
statements which would result in lower profit as this would reduce the audit fee income

Implications of the acquisition of Canary Co for audit planning

Obtaining an understanding of Canary Co, its environment and internal controls Obtain an
understanding of the relevant industry, regulatory and other external factors, the nature of the
company’s operations, ownership and governance structures, its selection and application of accounting
policies, its objectives and strategies, and the measurement and review of its financial performance.
Without this knowledge of the business we will be unable to properly perform risk assessment

The auditor should obtain an understanding of internal controls relevant to the audit. Therefore we
must document our understanding of Canary Co’s accounting systems and internal controls. This is
important given that Canary Co has different IT systems to the rest of the group

Preliminary analytical review – Need to perform a detailed preliminary analytical review on a full set of
Canary Co’s financial statements to fully understand the financial performance and position of the
company, and to begin to form a view on materiality. This review will also highlight any significant
transactions that have occurred this year.

Communicate with predecessor auditor As this is an initial audit engagement, we are required by ISA
300 to communicate with the predecessor auditor. Should contact the predecessor auditor and enquire
regarding matters which may influence our audit strategy and plan.

Opening balances As the opening balances were audited by another firm, we should plan to perform
additional work on opening balances as required by ISA 510

Consolidated financial statements audit

Significant component ISA 600 requires that the group auditor must identify whether components of
the group are significant components.

Inter‐company transactions As our firm is auditing the individual financial statements of Canary Co, our
risk assessment and planned response to risks identified at individual company level will also be relevant
to the audit of the consolidated financial statements. However, we must also plan to obtain audit
evidence in respect of balances and transactions which only become relevant on consolidation, such as
any inter‐company transactions that may occur

Materiality Materiality needs to be assessed based on the new, enlarged group structure. Materiality
for the group financial statements as a whole shall be determined when establishing the overall group
audit strategy

Non‐coterminous year‐end A significant matter which must be addressed is that of the different
financial year end of Canary Co. We will have audited Canary Co’s figures to its year end of 30 June 20X2,
but an additional month will be consolidated to bring the accounts into line with the 31 July year end of
the rest of the CS Group. Therefore, additional procedures will have to be planned to gain audit
evidence on significant events and transactions of Canary Co which occur in July 20X2.

Additional time and resource Finally, we must ensure that sufficient time and resource is allocated to
the audit of the consolidated financial statements as there will be additional work to perform on
auditing the acquisition itself, including the goodwill asset, the fair value of assets acquired, the cash
outflows, the contingent consideration, and the notes to the financial statement

Ethical and professional issues

The audit manager or partner should arrange a meeting with the senior management and the audit
committee, if one exists, and they should explain how the audit has to be performed and how the fee is
calculated.

They should take care to explain the professionalstandards which they have to comply with and the
terms of the engagement which the client agreed to, specifically that management should provide all
necessary documents and explanations deemed necessary by the auditor to collect sufficient
appropriate evidence. It should be explained that due to the need to comply with these standards, they

cannot guarantee to reduce either the volume of procedures or the audit fee.

If the audit proceeds, it should be ensured that the planning is performed by an appropriately
experienced member of the audit team. This should be reviewed thoroughly by the audit manager and
the partner to ensure that the procedures recommended are appropriate to the risk assessment
performed. In this way Magpie & Co can ensure that any unnecessary, and potential time wasting,
procedures are avoided

The audit manager should then make sure that Steve Eagle is given adequate notice of the timing of the
audit and provide him with a list of documentation which will be required during the course of the
auditso that he may prepare for the visit by the audit team.

The overdue fees create a self‐interest threat. A self‐interest threat may be created if fees due from an
audit client remain unpaid for a long time, especially if not paid before the issue of the auditor’s report
for the following year.

The audit firm should determine the amount of fee which is unpaid, and whether it could be perceived
to be a loan made to the client. It may be a relatively insignificant amount, and it may not be long
overdue, in which case the threat to objectivity is not significant.
If the self‐interest threat is significant, then no audit work should be performed until the fees are paid. T

Business Risks
Advertising regulations The company risks running inappropriate advertising campaigns, and failing to
comply with local variations in regulatory requirements. Could face fines and reputational damage, with
consequences for cash flow and revenue streams.

Skilled personnel- Loss of personnel, especially to competitors in the industry, would be a drain on the
remaining resources and in the worst case scenario it could delay the development and launch of new
products.

Diversification and rapid growth - Diversification has commercial and strategic advantages, it can bring
risks. Management may struggle to deal with the increased number of operations which they need to
monitor and control, or they may focus so much on ensuring the success of the new business segments
that existing activities are neglected. There may also be additional costs associated with the
diversification which puts pressure on cash

Imported goods – exchange rate fluctuations Connolly Co imports all of its packaging from overseas.
This exposes the company to exchange rate volatility and consequentially cash flow fluctuations. The
company chooses not to mitigate this risk by using forward exchange contracts. Exchange gains and
losses can also cause volatility in profits.

Imported goods – transportation issues Heavy reliance on imports means that transportation costs will
be high and this will put pressure on Connolly Co’s margins. Reliance on imports is risky as supply could
be disrupted due to aviation problems.Increases the likelihood of stockouts.

Reliance on single Supplier This level of reliance is extremely risky, as any disruption to the supplier’s
operations, for example, due to financial difficulties or political interference, could result in the
curtailment of supply, leading to similar problems of stock outs and halted production as discussed
above.

Change in key management The loss of several directors during the year is a business risk as it means
that the company may lose important experience and skills. It will take time for the new directors to
build up business knowledge and to develop and begin to implement successful business strategies.

Regulatory issues This creates a significant compliance risk for Grohl Co, which could lead to
investigation by the regulatory authority, and non‐compliance may result in forced cessation of
production, fines, penalties and bad publicity

Reliance on key customers Grohl Co relies on only 20 key customers to generate its domestic revenue,
which accounts for approximately half of its total revenue. In a competitive market, it may be difficult to
retain customers without cutting prices, which will place further pressure on profit margins.

Additional finance taken out – liquidity/solvency issues - , increasing the company’s gearing, and
creating an obligation to fund interest payments of $1.2 million per annum, as well as repayments of
capital in the future. does not appear to be cash‐rich, with only $130,000 cash available at the year‐end,
and having built up an overdraft of $2.5 million in July, working capital management may be a long‐term
problem for the company. The current and quick ratios also indicate that Grohl Co would struggle to pay
debts as they fall due.

RMM
Segmental reporting The diversification into the new product area relating to animal health may
warrant separate disclosure according to IFRS 8 Operating Segments. This requires listed companies to
disclose in a note to the financial statements the performance of the company disaggregated over its
operating or geographical segments.

Inherent risk of management bias – Raising Finance- Connolly Co’s management is attempting to raise
finance, and the bank will use its financial statements as part of their lending decision. There is therefore
pressure on management to present a favourable position. This may lead to bias in how balances and
transactions are measured and presented. For example, there is a risk that earnings management
techniques are used to overstate revenue and understate expenses in order to maximise the profit
recognised.

Research and development costs – recognition There is a significant risk that the requirements of IAS 38
Intangible Assets have not been followed. Research costs must be expensed and strict criteria must be
applied to development expenditure to determine whether it should be capitalised and recognised as an
intangible asset. The risk is that research costs have been inappropriately classified as development
costs and then capitalised, overstating assets and understating expenses

Development costs – amortisation When an intangible asset has a finite useful life, it should be
amortised systematically over that life. For a development asset, the amortisation should correspond
with the pattern of economic benefits generated from the sale of associated goods. The risk is that the
amortisation period has not been appropriately assessed. For example, if a competitor introduces a
successful rival product which reduces the period over which Connolly Co’s product will generate
economic benefit, this should be reflected in a reduction in the period over which that product is
amortised, resulting in an increased amortisation charge

Foreign currency transactions – initial recognition According to IAS 21, foreign currency transactions
should be initially recognised having been translated using the spot rate, or an average rate may be used
if exchange rates do not fluctuate significantly. The risk on initial recognition is that an inappropriate
exchange rate has been used in the translation of the amount

Foreign currency transactions – exchange gains and losses Further risk arises in the accounting
treatment of balances relating to foreign currency at the year‐end. Payables denominated in a foreign
currency must be retranslated using the closing rate, with exchange gains or losses recognised in profit
or loss for the year.

Product recall – refunds to customers. If the customer had already paid for the goods, a provision
should be recognised for the refund, as the original sale and subsequent product recall would create an
obligation. If the customer had not already paid for the goods and did not want a replacement, then the
balance on the customer’s receivables account should be written off. There is a risk of overstated profits
and either understated provisions or overstated current assets if the necessary adjustment for any
refunds is not made
Additional finance – capitalisation of new production line The new production process would appear to
be a significant piece of capital expenditure, and it is crucial that directly attributable costs are
appropriately capitalised according to IAS 16 Property, Plant and Equipment and IAS 23 Borrowing Costs.
Directly attributable finance costs must be capitalised during the period of construction of the
processing line, and if they have not been capitalised, non‐current assets will be understated and profit
understated.

New regulations – valuation of existing production facilities There is a risk that the existing production
facilities are impaired. This is due to the new regulations which come into force next year, and may
make at least part of the existing facilities redundant when the new production line is ready for use. IAS
36 Impairment of Assets identifies adverse changes in the legal environment as an external indicator of
potential impairment.

Additional finance – measurement and disclosure of loan The loan taken out is a financial liability and
must be accounted for in accordance with IFRS 9 Financial Instruments, which states that financial
liabilities must be classified and measured at amortised cost using the effective interest method. The risk
is that amortised cost has not been applied, meaning that finance costs have not accrued on the loan.

The loan will be repaid at a significant premium of $20 million, which should be recognised as finance
cost over the period of the loan using the amortised cost measurement method according to IFRS 9
Financial Instruments. A risk of misstatement arises if the premium relating to this financial year has not
been included in finance cost.

In addition, finance costs could be understated if interest payable has not been accrued.

The fact that the finance cost in the draft statement of profit or loss has remained static indicates that
this may have happened, resulting in understated finance costs and understated liabilities. There is also
a risk that necessary disclosures under IFRS 7 Financial Instruments: Disclosures have not been made.
The notes to the financial statements should contain narrative and numerical disclosures regarding risk
exposures, and given the materiality of the loan, it is likely that disclosure would be necessary

Canary Co management As this is the first time that Canary Co’s management will be involved with
group financial reporting, they will be unfamiliar with the processes used and information required by
the CS Group in preparing the consolidated financial statements. There is a risk that information
provided may be inaccurate or incomplete, for example in relation to inter‐company transactions.

Goodwill. The various components of goodwill have specific risks attached.

For the consideration, the contingent element of the consideration is inherently risky, as its
measurement involves a judgment as to the probability of the amount being paid. Currently, the full
amount of contingent consideration is recognized, indicating that the amount is certain to be paid. IFRS
3 contingent consideration is recognized at fair value at the time of the business combination, meaning
that the probability of payment should be used in measuring the amount of consideration that is
recognized at acquisition. This part of the consideration could therefore be overstated, if the assessment
of probability of payment is incorrect.

Another risk is that the contingent consideration does not appear to have been discounted to present
value as required by IFRS 3, again indicating that it is overstated.
The other component of the goodwill calculation is the value of identifiable assets acquired, which IFRS
3 requires to be measured at fair value at the date of acquisition. This again is inherently risky, as
estimating fair value can involve uncertainty.

Goodwill should be tested for impairment annually according to IAS 36 Impairment of Assets, and a test
should be performed in the year of acquisition, regardless of whether indicators of impairment exist.
There is therefore a risk that goodwill may be overstated if management has not conducted an
impairment test at the year‐end.

Lacks finance director One of the subsidiaries currently lacks a finance director. This means that there
may be a lack of personnel with appropriate financial reporting and accounting skills, increasing the
likelihood of error in Starling Co’s individual financial statements, and meaning that inputs to the
consolidated financial statements are also at risk of error.

SECTION A
13. a) Business Risks

1. Exchange rate fluctuations- Eposes the co. to exchange rate volatility and cash flow fluctuations.
Exchange gains and losses can also cause volatility in profits.

2. Transportation issues for imprted goods- T Costs will be high, fuel inc will put pressure on Profit
margins. Risky as supply could be disrupted due to aviation probs. Increases likelihood of stock out.

3. Reliance on single supplier- Risky as any disruptions to the supplier’s operations could result in the
curtailment of supply, leading to stock outs.

4. High tech and competitive industry- Subject to rapid product development. Need to adapt quickly to
changing demands in the marketplace but it may not have the resourced to do so.

5. Reliance on key customers – In a comp market, it may be diff to retain customers without cutting
prces, which will place further pressure on margins.

6. Additional loan- Inc gearing and creates an obligation to fund interest payments per annum in uture

7. Change in key mgmt.- Loss of directors is a BR as it means that the co. may lose imp experience and
skills. Will take time for the new directors to build up knowledge and to develop an begin to implement
successful bz strategies.

b) RMM

1. Foreign currency transactions – initial recognition - According to IAS 21 The Effects of Changes in
Foreign Exchange Rates, foreign currency transactions should be initially recognised having been
translated using the spot rate, or an average rate may be used if exchange rates do not fluctuate
significantly. The risk on initial recognition is that an inappropriate exchange rate has been used in the
translation of the amount, causing an inaccurate expense, current liability and inventory valuation to be
recorded, which may be over or understated in value.

2. Foreign currency transactions – exchange gains and losses- Payables denominated in a foreign
currency must be retranslated using the closing rate, with exchange gains or losses recognised in profit
or loss for the year. The risk is that the year-end retranslation does not take place, or that an
inappropriate exchange rate is used for the retranslation, leading to over or understated current
liabilities and operating expenses.

3. Obsolete Inventory - The risk is that inventory has not been reduced in value, leading to overstated
current assets and overstated operating profit.

4. Refunds to customers – Provision should be rec, risk of overstated profits and either understand
provisions.

5. Additional finance- measurement and disclosure of loan- IFRS 9 States that FL must be classified and
measured at amortized cost using the effective interest method. Risk that ammortised cost has not been
applied meaning that finance costs have not accrued on the loan. Risk that necessary disclosures under
IFRS 7 have not been made,

d) Audit manager joining client

Familiarity or intimidation threats may be created by employment with an audit client.

FT caused by the relationship that AM has with the audit team, this may case the audit team to fail to
cahlenege him sufficientlty and lose professional skepticism

IT- Junior members of the aaudit team may feel intimidated by him as his previous position. He will also
be aware of the firm’s audit methodology and procedures making it easier for him to circumvent
procedures.

If a former member of the audit team has joined the audit client that in a position that can influence the
preparation of fs. The threat would be so sign that no safeguards could reduce it to a acceptable level.

There may have been a self interest threat that if BOB knew he was ging to apply for the role at the
same time as performing work for the client. Any work that he performed recently should be subject to
review to ensure his objectivity has not been impaired.

Contingent Fee

Creates a self-interest threat to the auditor’s objectivity and independence that are so significant that
they cannot be eliminated or reduced to an acceptable level by the application of any safeguards.

The basis for the calculation of the audit fee is agreed with the audited entity each year before
significant audit work is undertaken.

e) NON-COMPLIANCE

ISA 250 states that while its mgmt’s resp to ensure that operations are conducted in accordance with
the provisions of the laws and regulation, the auditor has some resp in relation to compliance with L and
R, esp where a non-compliance has an impact of the F/S.
Isa 250 requires that when nc is identified or suspected, the auditor Shall obtain an understanding of the
nature of the act and the circumstances in which it has occurred and further info to evaluate possible
efcect on the FS.

Perform procedure on the suspected NC.

Discuss matters with mgmt. and where appropriate TCWG.

Implications on the fs

A needs to consider the potential implications for the FS. NC could lead to regulatory authorities
imposing fines or penalties on the Group which may need to be provided in fs.

Reporting resp

ISA 250 and NOCLAR require the auditor to determine whether they should report the identified or
suspected N to parties outside the entity. In the event that TCWG do not make proper disclosures to the
regulatory authorities, the auditor shall make them. Will depend on matters including whether there is
legal duty to disclose or whether it is considered to be in public interest to do so.