SEMESTER 2 2012-PRACTICE EXAM BAO5524 PROFESSIONAL AUDITING

ATTEMPT ALL QUESTIONS

Part one-Short answer questions(Chapters 1,3,6,8,11,12,18)Question 1Describe the principal agent relationship and how it is used to explain the development of auditing. (5 marks)

Question 2

What is the purpose of performing analytical procedures at the planning stage of an audit? Explain in brief. (6 marks) Question 3

Why do auditors want to rely on internal controls wherever possible? Mention four different types of procedures that an auditor might use when carrying out tests of controls. (5 marks)Question 4Explain the difference between the audit committees responsibilities for the external auditor and its responsibilities for the internal audit and any relevant regulatory audit functions. (6 marks)

Question 5

What is a management representation letter? Who prepares it? List some items that might be included in it. (8 marks) Question 6State what is meant by the term mandatory peer review. What are the implications of it for the profession?

(4 marks)Question 7List the purposes of audit documentation (working papers) and explain why each purpose is important.

(6 marks) (Total marks for part one = 40 marks)Part two-Case StudiesQuestion 8-Audit Risk-Chapter 9

Consider the following independent situations, all of which apply to audits of entities for the year ending 31 December 2011:

(i)Slipway Limited, a listed company, has been experiencing declining sales over the last 2 years. Cost cutting has proved difficult due to the high level of imported machinery used in Slipways operations and consequently margins have been falling. While the bankers are presently happy to continue providing Slipway with loan facilities, they do expect to see improved results in the next financial report. Articles about Slipways expected financial results appearing in recent press reports all had quite a pessimistic tone.

(ii)Discount Foods Limited is a large supermarket chain with offices in all capital cities around Australia. Until 30 June 2011 data processing relating to payroll transactions will be carried out in each capital city by an independent computer service bureau.

(iii)Getaway Pty. Limited is a long established firm which has been operating a boutique hotel in the Blue Mountains for over 20 years. During this time, it has adopted a conservative business strategy that has seen it produce adequate, though slightly unimpressive, results. A new CEO has been appointed to run the firm from 1 September 2011. He has already released his plans for renovating the hotel, despite not officially serving as CEO yet. You have also heard him discuss the implementation of a new marketing strategy to boost occupancy rates.

(iv)Angora Pty. Limited is a small primary producer specializing in the production of angora wool. Angoras recent display at a trade show has seen orders flood in from overseas buyers. The accountant, Michael, has done his best to satisfy the orders as quickly as possible while maintaining the appropriate (foreign currency) accounting records. However, from some of the questions he has been asking you, you suspect he is out of his depth.

(v)Kings Pty. Limited has been manufacturing uniforms for the Australian market for the last 40 years. The governments recent tariff reduction policy has placed Kings in direct competition with cheaper uniforms manufactured overseas. In a bid to retain market share, Kings has been selling part of its school uniform range at less than cost. However, overall profit figures remain buoyant.

(vi)Micro Pty. Limiteds best selling product line is the M4 - a `no frills microwave oven designed for domestic use. Over the last 2 months, warranty claims on the M4 have trebled from 1.5% to 4.5% of sales. The problem appears to relate to the glass turntable, which shatters if the oven is constantly used. The average cost of repair has risen by 20% to $200 per claim.

Required:

For each of the above independent situations, explain how the specific component(s) of audit risk are affected. (10 marks) Question 9-Subsequent events-Chapter 18

Consider each of the following independent and material situations. In each case:

the balance date is 31 October 2011.

the fieldwork was completed on 5 December 2011.

the financial report and audit report were signed on 12 December 2011.

the financial report and audit report were mailed to the members on 20 December 2011.1. Your client, Outback Mining, owns a mineral exploration licence in Central Australia. At 31 October this licence was valued by an independent expert at $50,000,000. This valuation is reflected in the financial report. On 8 December Outback Mining received notice that a claim was being lodged under the Native Titles Act for land which was included under the exploration licence. If the claim is successful the exploration licence will be worthless.

2. Your client, Bird Pty Limited, derives approximately 10% of revenues from selling aviary supplies to city-based bird breeders. A draft copy of a government report, leaked to the press and reported in the media on 11 November, recommends that strict limits be placed on the number of birds that are allowed to be kept in suburban areas. Bird Pty Limited estimates that if the recommendations are enacted, about 70% of its customers will have to cut their flocks by 50% or more. This would affect not only future sales but also their ability to pay existing debts. No further information, other than the draft report, is available as at 12 December.3. Your client, Gem Pty Limited, made an out of court settlement on 1 December 2011 of $300,000. The settlement related to a litigation case dating back 4 years. A provision of $150,000 was recorded in the 31 October 2011 financial report.

4. On 14 December 2011, you discover that a debtor of your client, Galaxy Ltd, was placed in provisional liquidation on 8 December. The debtor owed $600,000 as at 31 October; a specific provision of $300,000 of this amount was made at this date. On very preliminary information, the likely payout to unsecured creditors is zero.5. A flood occurred in the warehouse of your client Super Spring Ltd on 2 November 2011. Inventory valued at $2m was destroyed. The directors believe only half of this value will be recovered from the insurers.

Required: For each of the above events (1) to (5), state the appropriate action (A) to (D) that the auditor would require in order to issue an unqualified opinion for the situation. Justify your response. The alternative actions are as follows:

(A)Client to adjust the 31 October 2011 financial report.

(B)Client to disclose the information in the notes to the 31 October 2011 financial report.

(C)Client to recall the 31 October 2011 financial report for revision.

(D)No action is required. (3 marks each =15 marks)Please present your answer in the following format in your answer booklet

EventAppropriate ActionReason/Reasons

1

Question 10-Audit Opinions Chapter 7 You are an audit partner finalizing your 30 June 2011 audits. The following material and independent matters have come to your attention:

1) Tanner Ltd is the defendant in a litigation case, of which the outcome is highly uncertain. If the case is settled in favour of the plaintiff, Tanner will be required to pay a substantial amount of cash, possibly requiring the sale of certain non-current assets. The litigation and possible effects have been properly disclosed in Note 26 to the financial statements.

2) Bishop Trust is a reporting entity. Ms Ford, the finance director, refuses to adopt AASB 124 Related Party Disclosures on the grounds that it requires information to be disclosed to the public that should remain known only to the parties concerned. You are satisfied that current financial statements are materially correct in all regards, apart from the non-compliance with AASB 124.

3) Telken Ltd is the parent entity of the Telken Group, a reporting entity. Your firm did not act as auditor of either Telfast Ltd or Teldane Ltd, the entities controlled by Telken. You were unable to obtain the auditors report for Telfast, although you do have a copy of the final draft auditors report, and the other auditors verbal assurance that an unqualified auditors report was issued. In addition, despite receiving a copy of the audited report for Teldane, you do not believe that the financial statements would be suitable for consolidation with the other entities in the group. This is because Teldane operates in Afghanistan, which has a vastly different accounting framework from that used in Australia. You have been able to quantify the financial effect of the required adjustments on the financial statements of the Telken Group. However, management has refused to make the adjustments and has consolidated the existing version of Teldanes financial statements.

4) During the year, Gillard Ltd has changed its method of accounting for long-term construction contracts. It properly reflected the effects of the change in the current years financial statements and restated the previous years statements. You are satisfied with the entitys justification for making the change. The change is discussed in Note 24 to the financial statements.

5) One month before the reporting date, Olivio Ltd had its computer system and backups sabotaged by a disgruntled ex-employee. Management has done its best to reconstruct the accounting records over the past couple of months but this has been increasingly difficult because so much time is taken up keeping the day to day operations of the company. Management prepared the year-end financial statements from the few accounting records remaining. You have serious doubts as to the accuracy of these figures and have been unable to verify any of the material balances. Required:

For each of the above circumstances (1) to (5), identify the audit opinion you would issue and provide the reasoning why.

(3 marks each = 15 marks).

Question 11 Chapter 11Northcote Pty Ltd is a construction company (building houses, offices and hotels) employing a large number of workers on various construction sites. The internal audit department of Northcote Pty Ltd is currently reviewing cash wages systems within the company.

The following information is available concerning the wages systems:

(i) Hours worked are recorded using a clocking in/out system. On arriving for work and at the end of each days work, each worker enters their unique employee number on a keypad.

(ii) Workers on each site are controlled by a foreman. The foreman has a record of all employee numbers and can issue temporary numbers for new employees.

(iii) Any overtime is calculated by the computerised wages system and added to the standard pay.

(iv) The two staff in the wages department make amendments to the computerised wages system in respect of employee holidays, illness, as well as setting up and maintaining all employee records.

(v) The computerised wages system calculates deductions from gross pay, such as employee taxes, and net pay. Finally a list of net cash payments for each employee is produced.

(vi) Cash is delivered to the wages office by secure courier.

(vii) The two staff place cash into wages packets for each employee along with a handwritten note of gross pay,deductions and net pay. The packets are given to the foreman for distribution to the individual employees.

Required:

a) Identify and explain weaknesses in Northcote Pty Ltds system of internal control over the wages system that could lead to mis-statements in the financial statements.

b) For each weakness, suggest an internal control to overcome that weakness. (10 marks)Question 12 Part one- Chapter 3 (3 marks)For each of the situations described below, identify whether the situation involves a violation of the ethical standards of the profession, and if so, indicate which principle would be violated. In each situation, the named person is a chartered accountant working in public practice.

(1) Due to the death of its financial controller, an audit client had its external auditor, Gemma Jones, perform the controllers job for a month until a replacement was found.

(2) The audit engagement partner of BNP Holdings, Brad Lee, is a regular golf partner of the firms CEO.

(3) Kevin Paul discloses confidential information about a client to its successor auditor.

(4) An audit client is unhappy with the level of audit fees its paying, believing they are too high for the time taken and services rendered. It tells its auditor, Michael Ng, that he needs to re-tender for the audit, quoting a substantially lower fee, if he wishes to retain the audit.

Part two- Chapter 5 (7 marks)Extragrow Ltd was a successful fertiliser company operating in New South Wales. The company had large inventories of fertiliser held in different locations throughout that state and Queensland. The annual audit for 30 June 2007 was completed by Detmold Forster, a firm of chartered accountants. It signed the auditors report on 25 August 2007.Manuremate Ltd made a successful takeover offer of Extragrow during September 2007.However, when the financial staff of Manuremate looked at the financial statements of Extragrow, they found that inventory was substantially overvalued. This resulted in Manuremate having offered a higher value for the company than it would have otherwise.Manuremate took court action against Detmold Forster for the losses it had incurred due to this overstatement.

In the subsequent court case, it was found that inventory had been overvalued because Detmold Forster relied on managements representations about the value. It appeared that a large amount of the inventory was worthless because it contained some damaging weeds. The review of the auditors working papers also discovered that its staff had not attended the stock count in Queensland, because the majority of the stock was in New South Wales. From the working papers, it was discovered that 40% of the stock was held in Queensland.

Required:

Discuss with reference to cases and legislation (where appropriate):

(a) Whether Detmold Forster was negligent in the conduct of the audit (b) Whether Manuremate would win their case -END OF EXAM-