2007s2_solutions

SCHOOL OF ACCOUNTING AND LAW FINAL EXAMINATIONCOURSE: ACCT 1111 AUDITING AND ASSURANCE SERVICES Semester Two 2007EXAMINER’S SOLUTIONSACCT 1111 - Auditing and Assurance Services - Solutions Semester 2, 2007SECTION AQUESTION ONEThe limitations of a financial report audit are:(a)An auditor works within fairly restrictive economic limits;(b)The auditor cannot be expected to detect management fraud;(c)There is a time constraint on the issuance of the report;(d)Alternative principles are permitted under Australian Accounting Standards;(e)Estimates are an inherent part of the accounting process, and(f)No one, including auditors, can foresee the outcome of uncertainties.QUESTION TWOAs well as assessing the risk that an error will not be detected, the auditor is also concerned with establishing the level at which errors distort the fairness of the financial statements. This implies that the auditor need only be concerned with items in the financial statements that have a …material‟ effect. Much time and cost can be spent by the auditor in checking small items where the benefit does not justify the cost. ASA 320 - Audit Materiality, paragraph 06, defines materiality as meaning:…in relation to information, that information which if o mitted, misstated or notdisclosed separately has the potential to adversely affect decisions about theallocation of scarce resources made by users of the financial report‟Simply stated, this means that generally an item is considered material if its non-disclosure, misstatement or omission would be likely to distort the view given by the financial statements.Materiality is a relative concept. An amount of $1000 may be material to a small business, whereas $1 million may not be material to a multinational company. Materiality will vary depending on the business concerned.The assessment of materiality is a matter of professional judgement. ASA 320. 12 suggest that materiality should be assessed by the auditor in two distinct ways.1)Materiality should be considered by the auditor when determining the nature,timing and extent of audit procedures; that is, in planning what needs to be done.2)Materiality is used in evaluating the effect of errors on the financial statements. QUESTION THREEThe important criteria are as follows:The assessment of control risk is a compulsory part of an audit. It is done to determine (1) how good the controls are and (2) whether the controls are being adhered to. Based on this assessment the auditor is able to determine the likelihood of there being errors in transactions. They are then in a position to be able to determine how many transactions they review when substantiating balances.QUESTION FOUR(a)Generalised audit software (GAS) refers to software packages that assist theauditor in carrying out variety of auditing procedures on computer basedrecords.(b)GAS – used in compliance tests to determine wether authorised prices wereused in pricing sales invoices or credit limits were exceeded.GAS – used in substantive testing: select and print audit samples; testCalculations and make computations summarise data and perform analyses,compare audit data with company records.QUESTION FIVEWhat is meant by the term “going concern”? Briefly explain thr ee auditprocedures the auditor may perform in assessing whether a company is a going concern.The entity is expected to continue in operation without any intention ornecessity to liquidate or to curtail significantly the scale of its operations.Audit procedures include:∙Reviewing events after the end of the financial reporting period;∙Analysing and discussing the latest available interim financialinformation;∙Examining compliance with the terms of debenture trust deeds and loan agreements:∙Attending or reading the minutes of meeting of shareholders, directors requesting from the entity‟s solicitor, information regarding any materiallegal matters;∙Considering the position of the entity concerning unfilled customer orders;∙Analysing the liquidity of the company;QUESTION SIXIdentify five ethical reasons why an auditor might reject an offer to be an auditor for a particular company.Five suggestions∙Owns significant shares∙The audit fees are the pre dominant income of the firm∙ A relationship with key officers exist∙The firm does not have the skills to do the audit∙The firm is not a registered audit firmQUESTION SEVENIn determining a preliminary audit strategy an auditor takes the following into consideration:-Knowledge of the client from previous audits.-Preliminary assessments of inherent risk and materiality.-an understanding of the industry in which the entity operates.-the complexity and sophistication of the entity‟s operations andinformation system.-SECTION B - Case StudiesSection B totals 50 marks. Answer the 2 questions.QUESTION ONE(a)The letter of representation is a memorandum written by managementconfirming that the information they have given concerning the valuation ofstocks is accurate to the best of their knowledge. It is part of the overallevidence but not a substitute for other substantive procedures.(b)The stocks that ere loaded into the ship on the 30/5/07 but did not arrive untilthe 15/7/07 will need to be included as inventory.(c)The materials identified by the auditor will need to be written off as obsoleteand removed from inventory.(d)If the company refused to change the figures then auditor would advise themthat they would qualify the report and that the shareholders would be advised of the problem or dispute.(e)The ratios are used to identify risk areas where movements appear unusual.These areas would be investigated. A low turnover of stock could mean: -sales are down-errors in the ledgers-obsolescenceQUESTION TWOEvent i);(a)Responsibilities of the auditor∙Prior to the date of signing the audit report, the auditor has a responsibility to undertake audit procedures which have a probability of discovering materialafter reporting date events.∙The auditor should continue to carry out these audit procedures as close and practical to the date the audit report is due to be signed.(b)Audit Procedures which should have been discovered the after reporting dateevent∙Reviewing minutes of board of director‟s meetings, and executives committee‟s meetings held after reporting date, but prior to the signing of the audit report∙Reviewing correspondence with Civil Aviation safety Authority∙Making enquires of Choo Ltd.‟s solicitors∙Making enquires of Choo Ltd.‟s management, wether there have been any developments relating to risk areas.(c)Reporting the after reporting date event∙Choo Ltd.‟s aviation licence was suspended on 7 January, which is after reporting date.∙Therefore the suspension of Choo Ltd.‟s aviation licence is a type 2 after reporting date event, which creates new conditions, which did not exist atreporting date.∙The suspension of the aviation licence has material effect on Choo Ltd.‟s operations; therefore it should be disclosed and noted in the financial report.The note should disclose:-The nature of the event –the suspension of Choo Ltd‟s Australian aviation licence from January 2007 to 12 February 2007;-The financial effect of the event on Choo Ltd. – Choo Ltd should detail the loss of revenue due to Choo‟s inability to transport cargo to or from Austral ia by air, during the suspension period. Furthermore, the damage to Choo Ltd.‟sreputation due to the suspension of Choo‟s Australian aviation licence mayresult in further loss of business even after the licence has been reinstated.- A statement to the ef fect: The suspension of Choo Ltd.‟s Australian aviation licence occurred after reporting date, and therefore the financial effect of thesuspension of Choo‟s Australian aviation licence has not been incorporated inthe financial statements for the year ended 31 December 2006.Event ii);(a)Responsibilities of the auditor∙After the date the audit report is signed, the auditor does not have any responsibility to undertake audit procedures.∙However, if after the date the audit report is signed, but before the date the financial report issued, the auditor becomes aware of an after reporting dateevent, which may materially affect the financial report, the auditor shouldinitiate discussion with management, and consider whether the financial report needs to be amended.∙If management amend the financial report, the auditor will need to provide management with a new audit report on the amended financial report. The new audit report shall be dated the same date as, (or no later date than); the date the Director‟s Sta tement on the amended financial report is signed.∙Furthermore, if management amend the financial report, the auditor has a responsibility to extend audit procedures, which have a high probability ofdiscovering material after reporting date events, up to the date the reissued audit report is due to be signed.∙Alternatively, if management does not amend the financial report, in circumstances where the auditor believed that the financial report should beamended, and the previously prepared audit report has not been released to Choo Ltd. The auditor should issue a new qualified audit report.∙If the previously prepared audit report has ahs not been released to Choo Ltd.The auditor should notify the board of directors and senior management of Choo, not to issue the audit report to third parties.∙If the previously prepared audit report is subsequently released by Choo Ltd. to third parties, the auditor must act in order to prevent reliance on the originalaudit report.(b) Audit procedures which should have discovered the after reporting date event ∙Reviewing minutes of board of director‟s meetings, and executives committee‟s meeting held after reporting date, but prior to the signing of the audit report∙Reviewing correspondence with the insurers∙Making enquires of Choo Ltd.‟s management, wether there have been any developments relating to risk areas(c) Reporting the after reporting date event∙Choo Ltd.‟s Antarctic supply ship was crushed and destroyed by ice flows on 29 December 2006, which is before reporting date∙Therefore the notification of the destruction of Choo Ltd.‟s Antarctic supply ship is a type 1 after reporting date event, which reveals for the first a condition which existed at reporting date.∙The destruction of Choo Ltd.‟s Antarctic supply ship has a material effect on Choo‟s operations; therefore the financial effect of the ships destruction must be incorporated in Choo‟s financial statements and notes for the financial yearended 31 December 2006. In particular, the following must be included inChoo;s financial report:The Antarctic supply ship must be removed from Property, Plant and equipment/ assets;The write- off/ loss of the Antarctic supply ship must be recognised as an expense in the Statement of Financial performance;The write-off/loss of the Antarctic supply ship must be separately disclosed in the notes to the financial statements, (because it is relevantin explaining the financial performance of Choo Ltd.).SECTION C。