Topic 2

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AUDITING & ASSURANCE TOPIC 2 (TUTORIAL 3) SOLUTIONS Semester 1, 2015 STUDENTS PLEASE MUST BE AWARE THAT THESE SOLUTIONS ARE ONLY A GUIDE. THE QUESTIONS MAY HAVE DIFFERENT OR ALTERNATIVE PERSPECTIVES NOT OUTLINED BELOW. THESE ARE OFTEN DISCUSSED IN THE TUTE. AS THE END OF SEMESTER EXAM WILL BE MAINLY THE APPLICATION OF AUDIT PRINCIPLES, CONCEPTS AND TECHNIQUES TO A CASE STUDY FORMAT, PLEASE ENSURE THAT YOU PREPARE THE QUESTION AND NOT RELY ENTIRELY ON THE SOLUTIONS. THANK YOU Chapter 3: Ethics, independence and corporate governance 3.6 Actual independence is the achievement of freedom from bias and personal interest. This is necessary if the auditor is to provide an independent opinion. Perceived independence is the belief of financial report users that actual independence has been achieved. This is necessary if the auditor’s opinion is to lend any credibility to the financial report. 3.12 Contingency fees are fees that are based on the outcome or result of the work performed. APES 110.290.222 prohibits contingency fees for assurance engagements, as they create a self-interest threat to independence. In some instances they may also lead to an advocacy threat. 3.16 The fundamental principle at risk is confidentiality. The audit firm (HC) does not have the client’s permission to disclose information to any party (including the employees), when the information has been acquired as a result of the audit engagement with BJL. (APES 110.140.1). 3.20 AAA Decision Model 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. Determine the ethical issue List the significant stakeholders.  Andrew  Harry  Harry’s family

 the accountant at Canning Ltd  the audit firm and its partners Define the ethical issues. 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? Identify the major principles, rules and values See APES 110.100 – 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. 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. Compare values and alternatives If Harry does nothing, he would not honour the major principles of integrity and honesty. However, there is a potential conflict with his duty to his wife and family. Assess the consequences Do nothing — short-term consequences  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. Do nothing — long-term consequences  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. Inform audit manager of suspicions — short-term consequences  Harry upholds his principles of integrity and objectivity.  Andrew might receive credit for the good work and gain a promotion instead of Harry. Inform audit manager of suspicions — long-term consequences

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 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. Discuss 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). Make your decision Either informing the audit manager of his suspicions or discussing the situation with Andrew would appear to be appropriate solutions. 3.21 As Enjoyment Ltd is not a proprietary company, the auditor can resign by notice in writing in accordance with s. 329(5) only if they have received consent from ASIC to resign. ASIC Regulatory Guide 26 indicates that ASIC will not consent to a resignation that does not take effect at the annual general meeting, unless there are exceptional circumstances. Resignations as a result of tendering and opinion shopping are not considered to be exceptional circumstances. Therefore, it is extremely unlikely that ASIC will consent to the auditor’s resignation. ASIC would like to see the auditors’ independence preserved— in other words it would expect the auditors to issue the qualified opinion the auditors believe to be appropriate. 3.23 Threat Explanation Safeguards Self- interest A self-interest threat exists because the audit firm may benefit from additional professional engagements and the auditor could be seen to be advocating for this service to be engaged.  Policies and procedures to prohibit individuals assisting the assurance client from making managerial decisions on behalf of the client.  Using professionals who are not members of the assurance team to provide the services.  Ensuring the audit firm does not commit the assurance client to the terms of any transaction or consummate a transaction on behalf of the client Self- review As the inventory system would be a key application to the provision of financial information and the work may be performed by another division of the audit firm, there is a risk of not evaluating the system appropriately when forming a judgement on the reliance to be placed on the inventory system. The  Have the system independently reviewed once implemented.  Have another assurance partner review the assurance work.  Ensure no members in the audit engagement team are involved in the IT consulting assignment.  Do not submit a proposal for the IT consulting assignment.  Obtain written representation from Bass that it takes responsibility for all management decisions regarding the

independence or appearance of independence is compromised. design and implementation process of the inventory management system. 3.24 a) The threats of self-interest and/or intimidation are both valid (APES 110.290.123). These cover the circumstance where there is a business relationship between an employee of the firm (in this case, Alex) who is a member of the audit team, and an employee of the audit client or other person (in this case, Jim, FTL’s CFO), who can exert significant influence over the preparation of the client’s financial records and financial report. Alex and Jim would be classified as having a business relationship that is not insignificant due to their joint ownership of a large stud in northern New South Wales; therefore, both of these threats are valid. Alex playing golf with Jim on a semi- regular basis does not by itself constitute a close personal relationship (APES 110.290.126). Nor does the purchase of laptops via a retail store on normal commercial terms present a threat to independence (APES 110.290.125), and there is no information in the question to suggest otherwise. b) Safeguard would be:  FTL should have a policy of doing a conflict check on employees that requires them to declare any business interests with clients or their key staff before they are assigned to audit clients. Actions to be taken include:  Remove Alex from the audit team if the safeguard had not worked.  Require Alex to sell his interest in the horse stud. 3.25 Issue Category of threat to independence Explanation Safeguard 1. LTH wants Geoff to promote its business. Intimidation threat Advocacy threat Chris presents an intimidation threat by saying that LTH will find it difficult to continue business engagements with CJ should Geoff refuse to represent LTH (APES 110.200.8). LTH wanting Geoff to present a speech to promote its business to attract more investors will create an advocacy The advocacy threat and the intimidation threat in relation to Geoff promoting LTH are significant, and no safeguards could reduce the threat to an acceptable level. Geoff should therefore refuse to accept this appointment.

threat (APES 110.200.6). 2. LTH is offering you and Geoff complimentary holiday vouchers. Self-interest threat Familiarity threat Chris made it clear, in giving the holiday voucher to you and Geoff, that he is anticipating they will reciprocate by way of a ‘smooth audit’. This gift is therefore neither trivial nor inconsequential, and thus creates self-interest and familiarity threats (APES 110.290.227). The self-interest and familiarity threats of the complimentary gift vouchers are significant, and no safeguards could reduce the threat to an acceptable level. Therefore, you and Geoff should refuse to accept these gifts. 3. Michael is related to LTH’s financial controller. Familiarity threat Intimidation threat Self-interest threat Michael’s father, who is LTH’s financial controller, has a significant influence over the preparation of LTH’s financial statements. Having Michael in the audit team creates self- interest, familiarity and intimidation threats (APES 110.290.128). The self-interest, familiarity and intimidation threats in relatio n to Michael’s relationship with LTH’s financial controller can be eliminated by removing Michael from the audit team. The threat could also be reduced to an acceptable level by structuring Michael’s responsibilities to ensure he does not deal with matters that are within the scope of his father’s responsibilities. 4. Annette was involved in the preparation of LTH’s financial report. Self-review threat Annette’s involvement with the audit team in reviewing LTH’s tax calculations, which she helped to prepare, creates a self-review threat (APES 110.290.140). The self-review threat of Annette having worked on LTH’s tax calculations can be eliminated by removing her from the audit engagement. The threat could also be reduced to an acceptable level by allocating someone else in the team to review Annette’s audit work, or structuring her responsibilities so that she does not audit the work she was involved with preparing

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during her assignment at LTH and advising her of the need to take a more sceptical attitude when conducting her audit work. 3.28 Albert Kennedy’s 15 % shareholding makes him a substantial shareholder. Substantial shareholders do not meet the definition of independent directors, even if a non-executive director. CFC is in breach of ASX Corporate Governance Council Recommendation 2.1, as it does not have a majority of independent directors and its chair is not independent. Therefore, CFC will need to disclose the breach and provide a reason for non-compliance.