FINAL EXAMINATION-solutions

SPRING SESSION 2010

SCHOOL OF ACCOUNTING
Student Family Name:
Student Given Names:
Student Number:
Tutor’s name and tutorial time

Unit Name (In Full): Auditing and Assurance Services

Unit Number: 200535
Time Allowed: Two (2) hours including reading time.
Number of Questions: Six (6) questions
Total Number of Pages: 18 (including the cover sheet)
Unit Co-ordinator’s Name: Dr Qingliang Tang
Assessor Dr Kym Butcher

INSTRUCTIONS
PLEASE READ CAREFULLY BEFORE PROCEEDING

1. Ensure your name and student number is written on the top of this examination paper.
2. Ensure your name and student number is written on top of the multiple-choice answer sheet.
3. This is a CLOSED BOOK examination. The Auditing and Assurance Standards Handbook
2010 is not permitted to be used in this examination.
4. The value of each question is indicated at the start of each question.
5. Non-programmable calculators are permitted.
6. Attempt all questions.
7. Answer multiple choice questions in the answer sheet provided.
8. Answer other nun-MC questions in the spaces provided within this examination paper.
Answers outside the spaces will not be marked.
9. This assessment is worth 60% of the overall assessment mark.

Question Marks available Marks awarded

1 15 Research
2 12 Case independence
3 20 Case audit opinion (report)
4 13 Big case Ethic: duty of care
5 20 Case audit risk
6 20 MPC
TOTAL 100 No Short Ans
DO NOT TAKE ANY PART OF THIS PAPER FROM THE EXAMINATION ROOM

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Question 1 (Research question) 15 marks

Review the Australian Treasury’s consultation paper: Audit Quality in Australia: A

Strategic Review, along with submissions made on the paper, and answer the
following:

(i) What is the major conclusion of the consultation paper? (2 marks)

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(ii) Discuss the reasons why you agree or disagree with the conclusion. (5 marks)
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(iii) Compare and contrast the Australian proposals with the approach taken in
at least one other country (e.g. UK or USA) (4 marks)
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(iv) Discuss the major variations in the concerns of the organisations that
submitted comments on the paper. (4 marks)
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Question 2 (12 marks)

Mr Ralph Storm has recently been appointed as an audit partner to a Big N audit firm.
One of his duties is to review the firm’s audit clients to ensure that the independence
requirements of APES110 Code of Ethics for Professional Accountants are being met.
His review revealed that several audit engagements were potentially in breach of the
APES110 independence requirements. The independent cases are listed in the table
below.

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Required:
For each concern:
(i) Identify potential threats to independence, and,
(ii) Recommend any safeguards to reduce any threats to independence.

Case Potential Threats to Safeguards to reduce threats

Independence to independence
(1 marks) (2 marks)
(a) The audit engagement partner for Familiarity threat Safeguards include:
one of the firm’s long-standing Rotate after 5 yrs term and not
clients, KAB Ltd, has been Sec 290.154 says that allow the partner/review
responsible for auditing the group’s using the same lead partner etc to participate in the
accounts since 1970. The partner is engagement partner, review for a period of two
on a first name basis with most of the audit review partner, or years
staff at the companies head office and engagement quality Independent internal quality
regularly participates in social control reviewer over a control review
activities of the company. prolonged period may
create a familiarity
threat.
(b) Vulcan Limited is a listed mining Self-interest threat: Per APES 110 para. 290.106,
and energy company. Sam DeBurgh the auditor in charge where a member of the
CA, the auditor in charge, recently holds an indirect assurance team has a material
purchased units in a managed financial interest in an indirect financial interest in an
investment fund. In its product audit client (APES 110 assurance client, the only
disclosure statement, the fund para. 290.106). available safeguards are to:
disclosed that Vulcan Limited was  dispose of the indirect
among its top 10 shareholding. financial interest prior to
the individual becoming a
member of the assurance
team, or
 remove the member of the
assurance team from the
engagement.

The issue in this case is

whether Sam’s interest is
‘material’. The preface to
APES 110, section 290, does
not give a definition, rather it
states ‘regard should be had to
the effect which an interest
might have or be seen to have
on the objectivity of a person
in a firm’.
(c) On completion of the fieldwork of Self interest and Sec 290.213 of APES110 says
an audit of a major superannuation familiarity threats that “when a firm or a member
company, you discover that the of the assurance team accepts
managing director of the client gifts or hospitality, unless the
offered the entire audit team value is clearly insignificant,

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corporate box tickets to the World the threats to independence
Cup Soccer Qualifying Manager at cannot be reduced to an
Telstra Stadium. Seven of the audit acceptable level by the
team members accepted the tickets application of any safeguard.
and took their partner to see the Consequently, a firm or a
game. member of the assurance team
should not accept any gifts or
hospitality”.

So, no safeguards – should

have declined tickets.
(d) The now-retired founding partner Self-review threat Per APES 110 para. 290.170, a
of Big N, Mr Allen, has long operated firm may provide an audit
a small proprietary company through client that is not a listed entity
which he and his brothers own with accounting and
several investment properties. Big N bookkeeping services of a
has performed the annual audit (as routine or mechanical nature,
required by the company’s provided any self-review threat
constitution) for the past two years. In is reduced to an acceptable
addition, it also processes the journal level. Where the threat is
entries prepared by Mr Allen, extracts clearly not insignificant,
the trial balance and prepares the safeguards might include:
financial report.  ensuring accounting
services are not performed
by a member of the
assurance team
 prohibiting the person
providing the accounting
services from making
managerial decisions on
behalf of the client
 requiring the source data
for the accounting entries
to be originated by the
client
 requiring the underlying
assumptions to be
originated and approved by
the client
 obtaining client approval
for any proposed journal
entries.

Question 3 (20 marks)

The financial statements of Dogs Retreat Ltd for the financial year ended 30 June
2009 show an operating profit after tax of $20 million and net assets of $50 million.
The auditors, Miss Toots Chartered Accountants, a middle tier Chartered Accountants
firm, were engaged to perform the audit of Dogs Retreat Ltd six weeks after financial
year end. Materiality for the audit was set at $250,000.

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Taking into account the following independent circumstances of Dogs Retreat Ltd, the
auditors give an unqualified opinion in each case.

Required:
For each independent case, (a) through (d), give a possible reason why the auditor
issued an unqualified audit opinion.

Case Possible reason why an unqualified

(a) The auditor was unable to confirm
accounts receivable balances totalling
$500,000 by direct communication with
debtors.
(b) Miss Toot’s Limited hired an actuary to
assist in auditing Dogs Retreat Ltd’s
complex accrued provision for
superannuation. The actuary’s findings are
reasonably close to the calculations made
by Dogs Retreat Ltd and support the
financial report.
(c) Dogs’ Retreat Ltd reported the value of
land held for re-sale as $1,000,000. An
independent valuation obtained by the
auditor determined that the land is valued
at $750,000.
(d) The provision for accumulated
depreciation for the warehouse Dog’s
Retreat Ltd uses as it’s head office is
understated by $150,000.
opinion was issued
(5 marks each)
An unqualified opinion was issued
because the auditor likely obtained
sufficient appropriate audit evidence by
another means, e.g., subsequent receipts
review, as to the existence and valuation
of the debtors.
An unqualified opinion would be issued
as the auditor has the right to rely on the
work of an expert in such a situation and
has therefore gathered sufficient
appropriate audit evidence to support the
financial report.
An unmodified opinion would be issued
if the client de-values the land
downwards by $250,000 from
$1,000,000 to $750,000 the value
obtained by the auditor.
An unmodified opinion would be issued
because the amount is immaterial.

Question 4: (13 marks)

Your firm, QEX, has audited the financial statements of Southern Financial
Management Group (SFM) for the years ended 30 June 2005, 2006, 2007 and 2008.
Every year an unqualified audit report was issued. SFM promoted investments in a
number of property development projects, including 10 projects using unsecured
mezzanine finance (a form of fundraising that covers the difference between what
banks are prepared to lend and the actual cost of the project). In September 2008 SFM

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went into liquidation. As a result, thousands of investors lost their savings and
retirement funds in the order of $750 million. Investors have launched a class action
against QEX claiming that the audits of SFM were negligently carried out as it failed
to identify issues relating to continued solvency and qualify the audit reports.
Required:
(a) Do you believe QEX owe the investors a duty of care? Provide reasons for
your decision, citing relevant case law where appropriate.(10 marks)
(b) Discuss whether the investors are likely to be successful in a common-law
action for negligence. Provide reasons for your decision. (3 marks)
Solution
(a) QEX do not appear to owe the investors a duty of care.
In the Hedley Byrne case, ‘special relationship’ was the term used to
describe the conditions under which a duty of care would be said to
exist. The advice must be given at the direct request of the recipient or
circumstances must be such that the adviser knew or ought to have
known that the advice being given would be relied on by a person such
as the recipient in the circumstances.
“Reasonable foreseeability” is said to exist where the plaintiff is either a
foreseeable user or a member of a foreseeable class of users of the
advice. In effect, this meant that an adviser could be liable to persons or
groups of whom the adviser had no direct knowledge. For example, in
the Scott Group case, the auditors owed a duty of care to a specific third
party of whom they were not aware but was part of a class of persons of
whom the auditor should have been aware would rely on their auditor
opinion. Another example is in the Columbia Coffee case. The court
indicated that the auditor owed a duty of care to a potential investor
because of a clause in the audit manual that acknowledged that ‘there
will be interested parties who read and rely on our reports, and this
extends beyond the persons who employ us’.
The test of proximity is a return to a narrower interpretation of a special
relationship. More recent cases such as AGC, Caparo and Esanda have
indicated that for a relationship of proximity to apply there must be some
factor indicating assumption of responsibility by the third party. This
requires the auditor to induce the third party to rely on the statement by
the auditor.
(b) In this case, there is no indication that QEX induced investors to rely on
the audited financial statements of SFM when making their investment
decisions. Therefore, the investors are unlikely to be successful in an
action for negligence.

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QUESTION 5 (20 MARKS)

Required:
For each of the four (4) key audit risks described below complete the following:
(i) Identify the component (s)of audit risk affected and explain why it is an audit risk
(ii) Identify the key account balance (s) affected
(iii) Identify the prime audit assertion (s) to be tested
(iv) Identify ONE audit procedure you would use in your audit program to address the reduce the risk of material misstatement.

The situations are independent of each other and are to be treated separately in your answers.

Description of audit risk Component of audit risk Key Account Prime Best audit
affected (1 mark) and Balance (s) Assertion procedure to
explanation as to why it is an Affected (1 mark) reduce risk
audit risk (1 mark) (1 mark) (1 mark)
(a) In the course of your preliminary High control risk – controls such Accounts Valuation and Subsequent receipts
analytical procedures, you identified that your as daily banking, bank rec’s, receivable allocation review
audit client appears to have a significant debt segregation of duties between OR
recovery problem. Further investigations receiving the cheques and Negative debtors
reveal that the company’s debtor balance is so applying them to appropriate confirmations
high because an employee was caught accounts are obviously not
misappropriating cheques received from working. Hence it is likely that NO tests of controls
customers for payments of their accounts. the accounts receivable balance is – audit strategy
Although the employee was subsequently likely to be misstated. would be
dismissed, the audit partner in charge of the predominately
engagement plans to place no reliance on the substantive
controls in the accounts receivable area.

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(b) As part of the audit of a major client’s Lowers Control risk-by ensuring Sales Occurrence Enquire about
debtors system, a junior member of the audit that all sales are made to procedures for
team informs you, the engagement audit authorised customers and checking credit for
partner, that debtor sales are subject to credit prevents bad and doubtful debts new customers.
approval. Credit checks are conducted on all by ensuring customers have the Select a sample of
new customers and credit limit checks are capacity to pay. sales and examine
done on all existing customers. evidenced of this
check being carried
out .
Enquire about
procedures for
checking credit
limits for existing
customers. Select a
sample of sales and
examine evidence
of credit limit check
before each sale.
(c) As part of the business risk assessment for High inherent risk, because of Payroll expense Occurrence Vouching from
a major audit client, the auditor reviews dismissal of payroll manager it is payroll listing to
monthly newsletters of the client and likely that payroll expense (and timesheets
discovered that six weeks prior to year end, associated liability accounts) are
the payroll manager was dismissed because it likely to be overstated due to the
was discovered he had included his wife and discovery of fictitious employees.
daughter on the payroll for the past five
years. The auditor has decided not to rely on High control risk – although the
controls to reduce the risk of material auditor is not relying on controls,
misstatement for the payroll area. it appears that the function of
preparing and approving the
payroll are not adequately

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 segregated.
(d) You are the audit engagement partner for High control risk- possibility of Cash balance Occurrence/Cut- Prepare a bank
a high risk insurance company. The company kiting, i.e., transferring funds o/s or off` transfers schedule
has known going concern issues. As part of between bank accounts to specifically for several days
developing your audit plan you are reviewing overinflate the cash balance so as cash prior.
your audit clients accounts payable system. to cover a cash shortage or disbursements Obtain a
You find that the duties of issuing cheques, improve the entities cash subsequent bank
recording cheques and reconciling the bank position. Cash is transferred from statement and trace
statements are all done by the accounts one bank account to another and all bank transfers
payable manager, who has been with the the cash receipt (cash deposit) is around balance
company for 30 yrs. recorded in the period under date.
audit, but the disbursement
(withdrawal) is not recorded until
the following period. During this
period the money transferred
appears to be in both bank
balances.

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Question 6: Multiple Choice Questions 20 marks

Question 1: The independence of an auditor would be impaired if the auditor:

a) Provided advisory service for a client
b) Joined a trade association, which is a client, and served in a non-management
capacity
c) Accepted a token gift from a client
d) Served as an executor and trustee of the estate of an individual who owned the
majority of the shares of a client

An: D

Question 2: Which of the following situations would most likely heighten an

auditor’s concern about the risk of intentional misstatement in the financial
report?
a) Turnover of senior accounting personnel is low
b) The entity recently established a new division overseas
c) Management places substantial emphasis on meeting earnings projections
d) The rate of change in the entity’s industry is slow

An: C

Question 3: In which of the following situations would an entity be assessed as

having high inherent risk?
a) Managers who helped to establish the company 10 years ago are still in place
b) Rapid growth in the US economy has led to increased export sales
c) The entity’s engineering product has a patent that will expire in 10 years time
d) The entity has just appointed an audit committee

An: B

Question 4: In General, material frauds perpetrated by which of the following

people are most difficult to detect?
a) Internal auditor
b) Keypunch operator
c) Cashier
d) Financial controller

An: D
Question 5: When an auditor increases the planned assessed level of control risk
because certain control procedures were determined to be ineffective, the auditor
would most likely increase the:
a) Extent of substantive tests
b) Level of inherent risk
c) Extent of tests of controls
d) Level of detection risk
An: A

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Question 6: In the weekly computer run to prepare payroll cheques, a cheque
was printed for an employee whose employment was terminated the previous
week. Which of the following controls, if properly used, would have been most
effective in preventing this error or ensuring its prompt detection?
a) A control total for hours worked, prepared from time cards collected by the
timekeeping department and compared to the payroll sheets
b) Requiring the accounting department to account for all pre-numbered cheques
issued to the IT department for the processing of the payroll
c) The use of check digits on employee numbers
d) The use of a header label on the payroll input sheet
An: A

Question 7: The auditor obtains evidence supporting the notion that proper
segregation of duties exists by:
a) Personally observing the employees who apply the control procedures
b) Reviewing job descriptions in the personnel department
c) Preparing a flowchart of duties performed by personnel
d) Performing tests to determine whether control procedures operated
consistently throughout the period
An: A

Question 8: Which of the following tests of controls would be most likely to help
assure an auditor that goods shipped are being properly billed? Checking that
the client has:
a) Scanned the sales journal for sequential and unusual entries
b) Examined shipping documents for matching sales invoices
c) Compared the accounts receivable ledger to daily sales summaries
d) Inspected unused sales invoices for consecutive pre-numbering

An: B

Question 9: In auditing the purchases system, an auditor vouches a sample of

entries in the voucher register (accounting records) to the supporting documents,
such as purchase order, receiving report and supplier invoice, to test whether the
control has operated effectively. Which assertion would this test of controls most
likely support?
a) Completeness
b) Occurrence
c) Accuracy
d) Classification

An: B

Question 10: An auditor reconciles the total of the accounts receivable subsidiary
ledger to the general ledger control account, as at 30 June 2010. By this
procedure, the auditor would be most likely to learn to which of the following?
a) An April cheque from a customer was posted in error to the account of another
customer with a similar name
b) An April invoice was improperly computed
c) An account balance is past due and should be written off

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 d) An opening balance in a subsidiary ledger account was improperly carried
forward from the previous accounting period
An: D

Question 11: To conceal defalcations involving receivables, the auditor would

expect an experienced bookkeeper to most likely charge which of the following
accounts?
a) Petty cash
b) Miscellaneous income
c) Sales returns
d) Miscellaneous expenses

An: C

Question 12: An auditor selected items that are on the store floor for test counts
while observing a client’s physical inventory. The auditor then traced the test
counts to the client’s inventory listing. This procedure most likely obtained
evidence concerning management’s assertion of:
a) Rights and obligations
b) Completeness
c) Existence
d) Valuation and allocation

An: B

Question 13: An auditor concluded that no excessive costs for idle plant were
charged to inventory in a client’s standard costing system. This conclusion most
likely related to the auditor’s objective to obtain evidence about the account
balance assertion for inventory of:
a) Valuation and allocation
b) Completeness
c) Existence
d) Rights and obligations
An: A

Question 14: The basic elements of the standard unqualified auditor’s report for
a Corporations Act 2001 audit include all of the following except:
a) a title that includes the word “independent”
b) a statement that the financial report is the responsibility of the company’s
directors
c) A statement that accounting estimates are reasonable, but that there will
normally be differences between estimated and actual results
d) A statement that an audit includes examining, on a test basis, evidence
supporting the amounts and disclosures in the financial report

An: C

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Question 15: Catherine Abbot, as principal auditor for the consolidated financial
report, finds that the audit (by another auditor) of a major subsidiary is
qualified. She does not consider the qualification to be material relative to the
consolidated financial report and is satisfied in all other regards. What
recognition, if any, must she make in her auditor’s report regarding the qualified
report of the auditor of the subsidiary?
a) She must refer to the qualification of the other auditor and qualify her report
likewise
b) She need make no reference to the qualified report
c) She must include the other auditor’s report with her report and give an
explanation of its significance
d) She must include the other auditor’s report with her report but need not qualify
her report
An: B

Question 16: Which of the following situations would not result in modification
of the auditor’s report because of a scope limitation?
a) Restriction on sighting inventory imposed by the client
b) Destruction of the accounting records in a fire
c) Inability to obtain sufficient competent evidential mater
d) Disagreement with those charged with governance over the application of an
accounting policy
An: D

Question 17: At the end of an audit, the auditor has two issues outstanding. The
first is a disagreement with those charged with governance concerning the use of
an inappropriate valuation method for inventory (LIFO). The second is
significant uncertainty as to whether the entity will continue as a going concern;
this is adequately disclosed in the notes to the accounts. What type of audit
opinion should the auditor express?
a) A qualified opinion with an Emphasis of Matter paragraph
b) An unqualified ipinion
c) A qualified opinion
d) An unqualified ipinion with an Emphasis of Matter paragraph
An: A

Question 18: Common law requires that the auditor:

a) Guarantee their work
b) Perform their work with due card
c) Discover all fraud
d) Check all transaction
An: B

Question 19: The AWA case established that:

a) Reasonable care and skill means following the auditing standards
b) Auditors have a duty to closely supervise and review the work of
inexperienced audit staff
c) Auditors are only liable for the proportion of damages attributable to their
actions
d) Auditors have a duty of care only to the shareholders as a group

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An: C

Question 20: The Pacific Acceptance case established that:

a) Reasonable care and skill means following the auditing standards
b) Auditors have a duty to closely supervise and review the work of
inexperienced audit staff
c) Auditors are only liable for the proportion of damages attributable to their
actions
d) Auditors have a duty of care only to the shareholders as a group
An: B

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