QP Module C (Jun 11)_Answer
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SECTION A – CASE QUESTIONS (Total: 50 marks)Answer 1B & Co is required to comply with the Code of Ethics for Professional Accountants (“the Code”) issued by the HKICPA. Section 290 of the Code provides guidance on this matter. Independence requires both independence of mind and independence in appearance. There are 2 independence issues that Julie should be place a concern:(i) Family and personal relationshipJulie is the audit manager-in-charge of ABC in which Thomas Chan, Julie’s uncle, is ABC’s new general manager and in charge of ABC’s expansion plan and system implementation. There is a close personal relationship between Julie and Thomas.It may create a familiarity threat.Familiarity threat occurs when due to a long or close relationship with an audit client, a professional accountant will be too sympathetic to their interests or too accepting of their work.Being Julie’s uncle, Thomas is senior than Julie. It may create intimidation threat when Thomas exerts significant influence through imposing pressure on Julie over the annual audit process especially on the system audit.Intimidation threat occurs when a professional accountant will be deterred from acting objectively because of actual or perceived pressures, including attempts to exercise undue influence over the professional accountant.(ii) Provision for IT systems services to an assurance clientSelf-review threat may be create if B & Co helps ABC on system design and implementation and later B & Co reviews the systems controls as part of its audit.Self review threat occurs when a firm or a professional accountant of the audit team could not appropriately evaluate the results of a previous judgement made or service performed by the professional accountant, or by another individual within the professional accountant's firm or employing organization, on which the accountant will rely when forming a judgement as part of providing a current service.Julie should recommend to Ben that the safeguards include the following:- Report to Ben her family relationship with Thomas and remove herself from the assurance team;- Use different partners and engagement teams with separate reporting lines from the audit engagement teams to assist ABC on system design and implementation;- Disclose to those charged with the governance that B & Co is engaged by ABC on system design and implementation and the extent of the fees charged;- Ensure there are policies put in place so that there is no exchange of confidential information between the assurance team and the non-assurance services team; and- Consider not accepting the provision of system design and implementation services to ABC.Answer 2B & Co should assess the impact of the implementation of “SUCCESS” and plan the audit procedures during the risk assessment process.B & Co should consider:- whether the audit team possesses the required expertise in auditing SAP “SUCCESS”; - the timing of the audit procedures, e.g. performing pre-implementation review or post-implementation review; and- the use of CAATs and other audit software in carrying out the journal entries testing.B & Co. should test the general controls and application controls on transactions processed by “SUCCESS” for authorisation, completeness and accuracy.In particular, B & Co. should plan the following audit procedures:- Question the project manager and obtain an understanding of the computer controls, operation system, database system and implementation issues, if any;- Understand, evaluate and validate the IT general controls, e.g. use of passwords, physical controls, controls over password, system development and maintenance controls, programming controls, transactions logs, firewalls, etc;- Understand and walk through the end-to-end processes to confirm if there is any change of management procedures upon the system implementation;- Evaluate and identify the key manual and IT application controls; and- Validate the key manual and IT application controls, e.g. pre-processing authorisation, data validation test, input error reporting and handling, file controls, master file controls, balancing, etc.In addition, B & Co. should also consider the audit procedures to ensure the data migrated from the old system to “SUCCESS” is complete and accurate. B & Co. should ensure that management’s control is in place for data migration and perform relevant substantive testing, e.g. reconcile the July opening balances with the June closing balances.The risk of material misstatement relating to the co mpleteness assertion of ABC’s accounts payable as at 31 December 2010 is low to medium.The last year audit results indicated no misstatement found on the accounts payable balance, even though the accounts payable confirmation replies of last year’s audit did not agree with the suppliers’ record s but this could be reconciled and explained by ABC.In addition, management has strengthened their internal controls over the completeness of accounts payable in the year by performing monthly reconciliations to s uppliers’ statements from overseas suppliers.Answer 3(b)B & Co should update their understanding of the purchase and payable processes of ABC, including relevant internal controls and accounting procedures, by inquiry, observation, examination and / or performing a walk-through test.Then B & Co. should evaluate the design effectiveness of the controls and identify those key controls which can mitigate the risk of material misstatements to the financial statements.Validate the operating effectiveness of the internal controls and accounting procedures over the purchase and payable processes during the year:- purchase orders are pre-numbered and approved by authorised persons;- goods received notes are pre-numbered and agreed with approved purchase orders;- matching of purchase orders, goods received notes and suppliers invoices before trade payables are recorded;- segregation of duties;- management controls on monthly reconciliation to suppliers’ statements from overseas suppliers; and- management cut-off procedures.B & Co. should also consider some of the following substantive procedures:- send confirmation to local suppliers;- select a sample of suppliers’ statements of local suppliers and trace to respective supplier’s accounts;- perform purchase cut-off test on purchase from local suppliers;- examine files of unmatched purchase orders and supplier invoices;- search for unrecorded liabilities;- compare the balance to the relevant purchase and the previous months / year; and- compare the payable s’ turnover and payables’ days to the previous year and industry data.The factors and procedures which should be considered in planning the year-end inventory count include:(i) Ensure the audit coverage of the physical count is appropriate- Confirm with management the nature and volume of the inventories in each of the 3 locations;- Identify high value items; and- Identify consignment inventories.(ii) Review management’s inventory count instructions- Method of counting for inventory (e.g. full count vs cycle count);- Restriction and control of the inventory movement during the count;- Use of count tags and serial numbering, control and return of all count tags; and- Recording of internal transfer.(iii) Understand and evaluate the appropriateness of ma nagement’s control over inventory count- Segregation of duties (e.g. accounting department assisted in inventory count);- Supervision by senior staff including senior staff not normally involved with inventory count (e.g. Thomas’ direct supervision of the in ventory count); and - Reconciliation of inventory records and investigation and correction of any differences.(iv) Because ABC’s inventory count is not performed on 31 December 2010, roll-forward procedures from the date of the inventory count to year end date should also be planned.Answer 4(b)The risk of material misstatement relating to the completeness and accuracy assertion of ABC’s inventories as at 31 December 2010 is medium.Inaccurate date of migration may affect the completeness assertion of the year-end inventory balance. However, the year-end inventory count performed by management, investigation of differences and correction to inventory sub-ledger mitigates the risk of material misstatement on completeness assertion.Miscommunication of user needs on inventory costing calculation to T&T on the design of IT controls in “SUCCESS” for calculating the inventory costing may increase the risk of material misstatement on accuracy assertion.Significant decrease in inventory balance and improvement of gross profit percentage compared to prior year may be an indicator of an increase in risk of material misstatement on accuracy assertion.B & Co. should update their understanding of the inventory processes of ABC, including relevant internal controls and accounting procedures, by inquiry, observation, examination and/ or performing a walk-through test.Then B & Co. should evaluate the design effectiveness of the controls and identify those key controls which can mitigate the risk of material misstatements to the financial statements.Validate the operating effectiveness of the internal controls and accounting procedures over the inventory processes during the year:- Inventory in and inventory out movements recording in “SUCCESS”;- Year-end inventory count and variance investigation; and- Application control of “SUCCESS” on inventory costing calculation.In addition, B & Co.’s computer audit department needs to understand, evaluate and valudate the data migration of invento ry from old system to new system “SUCCESS”.B & Co. should also consider some of the following substantive procedures:- Perform physical inventory count on both 1 July 2010 and 31 December 2010;- Trace test counts to the detailed inventory listing as at 31 December 2010; and- Analytical procedures e.g. compare the group profit percentage with the previous year and industry data.* * * END OF SECTION A * * *SECTION B – ESSAY / SHORT QUESTIONS (Total: 50 marks)Answer 5(a)T&F’s corporat e governance may be improved in the following ways:Split the roles of chairman and chief executive officer (“CEO”)Mr. Lee’s current roles as chairman and CEO of T&F should be separated between different individuals.The CEO should manage the company, whilst the chairman should run the board.Lack of audit committeeT&F should form an audit committee with specific written terms of reference which reports back to the board on their decisions or recommendations relating to audit, accountability and financial reporting matters.Appointing a separate audit committee helps T&F’s board to concentrate on strategic and operational matters, leaving the audit committee to undertake the detailed financial reporting, internal control and financial review matters.An internal audit department may be formed to report to the audit committee.Balanced compositions of the boardDirectors on T&F’s board do not have any financial expertise. T&F’s board should include a balanced composition of executives and non-executives drawing from a range of relevant expertise.In any kind of business, financial expertise is important. T&F should invite someone with financial expertise to join its board.Answer 5(b)HKSA 240 (Clarified) The Auditor’s Responsibilities relating to Fraud in an Audit of Financial Statements requires that, an auditor conducting an audit in accordance with Hong Kong Standards on Auditing, is responsible for obtaining reasonable assurance that the financial statements taken as a whole are free from material misstatement, whether caused by fraud or error.Owing to the inherent limitations of an audit, there is an unavoidable risk that some material misstatements of the financial statements may not be detected, even though the audit is properly planned and performed in accordance with Hong Kong Standards on Auditing.The three pre-requisites that generally present when a fraud takes place are as follows:- an incentive or pressure to commit fraud;- a perceived opportunity to commit fraud; and- some rationalisation of the fraudulent act.Answer 5(c)The three fraud risk factors from the perspective of T&F’s auditor are:T&F’s desire for a listingT&F’s desire for a listing within a year or two increases the pressures of inflating the sales and profits in order to meet the listing requirements.Rapid growth and unusual profitabilityT&F’s sales have been almost doubled from 2009 to 2010 [482,100,000 / 254,300,000]. Despite the stable gross margin (ranging between 29% an d 30%), T&F’s net profits before tax has increased five times [98,100,000 / 16,200,000].Such financial instability may represent misstatements arising from fraudulent financial reporting.Questionable liquidityT&F’s current ratio has fallen from 1.2 to 0.9 despite the significant increase in profits.The combination of rapidly rising profitability and questionable liquidity may represent misstatements arising from fraudulent financial reporting or misappropriation of assets.Also, the difficulties in liquidity may increase the pressures to commit fraudulent financial reporting.T&F’s questionable liquidity may also explain the desire to go for a listing within a year or two.The amount shown in X Limited’s trade receivables should be the outstanding amount on trade receivables less impairment loss for irrecoverable debt.Audit procedures on sales and trade receivables are usually combined due to the inter-relationship between the two items in accounting procedures and internal control systems.X Limited’s auditor should understand and evaluate the major activities that X Limited uses to monitor internal control over financial reporting which, in this case, include the design and operating effectiveness of the accounting procedures and internal controls relating to sales and trade receivables. These accounting procedures and internal controls should cover:- billing procedures and recordings of sales and receivables;- quality assurance / control procedures over products before and after delivery;- credit policies and controls;- collection of trade receivables; and- procedures adopted by X Limited’s management in the identification and estimate of impairment loss for irrecoverable debt.X Limited’s auditor should carry out some of the following substantive procedures:- send a confirmation to C Limited and other debtors;- compare the balance to the relevant turnover and previous months / years;- compare the aged analysis to other debtors and previous months / years;- discuss with management (and X Limited’s lawyer) the nature and status of the dispute; - discuss with management (and X Limited’s lawyer) the recoverability of the entire balance HK$2,589,000;- discuss with management the implications (if any) of C Limited’s claims (product quality) on other debtors or accounts;- check for any subsequent settlement from C Limited and other long outstanding debtors;and- check for any returns of goods from C Limited and other customers.HKSQC 1 (Clarified) Quality Control for Firms that Perform Audits and Reviews of Financial Statements, and Other Assurance and Related Services Engagements requires your firm to consider and document certain matters before continuing to serve as PQR’s auditor.Those matters include:- the integrity of PQR (i.e. its shareholders, directors and management);- whether your firm is competent to do the work; and- whether your firm meets ethical requirements in relation to the work.There is no clear evidence compromising the integrity of PQR even though you may question the source of the new funding into PQR.As your firm has been the auditor of PQR for six years, competency is not likely to be questioned.However, the increase of PQR’s scale of activiti es and its forthcoming overseas acquisitions may challenge your firm’s competency.Challenges may include the industries, locations and sizes of those companies being acquired as well as the forms of investments (e.g. equity, debt or quasi-equity) and the availability of properly audited financial statements.Being associated with PQR (as its auditor) for six years may indicate a close relationship. However, it is not entirely clear if the extent of relationship may pose any familiarity threat to your firm.You should be satisfied that appropriate procedures regarding the continuance of client relationship and audit engagement with PQR have been followed, and that conclusions reached in this regard are appropriate and have been documented.* * * END OF EXAMINATION PAPER * * *。
