DIA703: Audit and Assurance
Term 3 2017
Mid-term Examination – Closed Book
Level 7 Credits 20
Assessment 1 Total Marks / Weighting 100 marks (40%)
Week Due Week 5 Duration 3 hours + 15 minutes reading time
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Student Signature Date
Assessor Name Total Marks / 100
Assessor Signature % Weighting / 40%
Section Section A Section B Question No Q1-Q15 Q1 Q2 Q3 Q4 Total Marks
15 20 20 15 30 100
DIA 703Audit and Assurance
Aim: To develop knowledge and understanding of the process of conducting the audit and assurance engagement and its application in the context of the professional regulatory framework of New Zealand.
Class Contact Hours 64
Lecturer supervised tutorial 36
Independent Learning 110
Total Student Learning Hours 200
LEARNING OUTCOMES ASSESSED
Learning Outcome Section Mark Allocation
LO1: Explain the nature, purpose and scope of regulatory and ethical framework and limitations of audit and assurance systems in assurance engagements.
Section B: Q2
Section B: Q3
Section B: Q4 5
LO2: Explain the nature and role of internal audit and its relationship with external auditor. Section A
Section B: Q1
LO3: Demonstrate the ability to understand the role and function of auditor, audit environment, current issues and liabilities facing external auditors in New Zealand.
Section B: Q3
Section B: Q4 5
Total 100 marks 100%
SECTION A – ALL 15 questions are compulsory and MUST be attempted. (Total: 15 marks)
(Learning Outcomes 1, 2, 3)
1. When dealing with audit risk: (1 mark)
A. Audit risk should not be a factor when determining if a new client should be accepted.
B. Audits with a low acceptable audit risk generally result in lower audit fees.
C. if management of a company has a reputation of integrity, but is also known to take aggressive financial risks, the auditor should not accept the company as a new client.
D. if the auditor concludes that acceptable audit risk is low, but the client is still acceptable, the auditor may still accept the engagement but increase the audit fee.
2. Which of the following is not an assurance engagement? (1 mark)
A. External audit
B. Internal Audit
C. Compilation engagement
D. Review Engagement
3. Directors must send out notice for meeting within ______ days of having received requisition by auditors. (1 mark)
4. Auditors can require directors to call __________________ to discuss circumstances of resignation. (1 mark)
A. A Board Meeting
B. An Extra Ordinary General Meeting
C. An Annual General Meeting
D. Any of the above
5. What makes a person ineligible for appointment as a company auditor? (1 mark)
A. An officer or employee of the company
B. A partner or employee of such a person
C. A partnership in which such a person is a partner
D. All of the above
6. The OECD principles strongly recommend: (1 mark)
A. An Annual Audit
B. Internal Audit
C. Directors should not receive pay
D. Directors should be non-executive
7. Which of the following are voluntary disclosures for breach of client confidentiality? (1 mark)
A. Auditor suspects’ client has committed treason
B. Auditor suspect’s client has committed fraud
C. Auditor knows client has committed terrorist offence
D. Auditor considers there to be non-compliance with law and regulations
8. When an auditor believes that an illegal act may have occurred, the auditor should first
A. Obtain an understanding of the nature and circumstances of the act.
B. consult with legal counsel or others knowledgeable about the illegal act.
C. discuss the matter with the audit committee.
D. withdraw from the engagement.
9. Ethics are (1 mark)
A. needed in the professions, but is not needed for society in general.
B. a set of moral principles or values.
C not formed by life experiences.
D. always incorporated in laws.
10. To obtain reasonable assurance about whether the financial statements as a whole are free from material misstatement, the auditor must fulfil several performance responsibilities, including:(1 mark)
A. Verifying that all audit work is performed by a CA/CPA with a minimum of three years’ experience.
B. Obtaining sufficient, appropriate audit evidence.
C. Exercising professional judgment.
D. Providing an opinion on the financial statements.
11. In order to properly plan and perform an audit, an important fact for both the auditor and the client to understand is that:(1 mark)
A. The internal control policies and procedures are developed by the auditors.
B. The purpose of an audit is to prevent fraud.
C. Management is responsible for the preparation of the financial statements.
D. Management can restrict the auditor’s access to important information relevant to the financial statements.
12. When an auditor believes that an illegal act may have occurred, the auditor should first:
A. Obtain an understanding of the nature and circumstances of the act.
B. Consult with legal counsel or others knowledgeable about the illegal act.
C. Discuss the matter with the audit committee.
D. Withdraw from the engagement.
13. Which of the following services provides the lowest level of assurance on a financial statement?(1 mark)
A. A review
B. An audit
C. Neither service provides assurance on financial statements.
D. Each service provides the same level of assurance on financial statements.
14. ________ means that a person acts according to conscience, regardless of the situation.(1 mark)
B. Due Care
15. Which of the following statements is the most correct regarding errors and fraud?
A. An error is unintentional, whereas fraud is intentional.
B. Frauds occur more often than errors in financial statements.
C. Errors are always fraud and frauds are always errors.
D. Auditors have more responsibility for finding fraud than errors.
SECTION B – ALL 4 questions are compulsory and MUST be attempted. (Total: 85 marks)
Question 1 (LO 2) (20 Marks)
Explain the role of internal audit department and of those of internal auditor especially to fraud. (10 Marks)
List out five differences between internal audit and External Audit (10 Marks)
Answer to Q1
The internal audit department has a two-fold role in relation to risk management:-
It monitor the company’s overall risk management policy to ensure it operates effectively. (1 mark)
It monitors the strategies implemented to ensure that they continue to operate effectively. (1 mark)
As a significant risk management policy in companies is to implement internal control, internal audit has a key role in assessing systems and testing control. (1 mark)
Internal audit may assist in the development of systems. However, its key role will be in monitoring the overall process and in providing assurance that the systems which the departments have designed meet objectives and operate effectively. (1.5 marks)
It is important that the internal audit department retains its objectively towards these aspects of its role, which is another reason why internal audit would generally not be involved in the assessment of risks and the design of the system. (1.5 marks)
As the internal auditor has a role in risk management he is involved in the process of managing the risk of fraud. (1 marks)
The internal auditor can help to prevent fraud by carrying out work on assessing the adequacy and effectiveness of control systems. The internal auditor can help to detect fraud by being mindful when carrying out his work and reporting and suspicions. (1.5 marks)
The very existence of an internal audit department may act as a deterrent to fraud. The internal auditors might also be called upon to undertake special projects to investigate a suspected fraud. (1.5 marks)
The following are the differences between Internal Audit and External Audit:
Particulars Internal Audit External Audit
Objective Designed to add value and improve an organization’s operations. An exercise to enable auditors to express an opinion on the financial statements.
Reporting Reports to the board of directors, or other people charged with governance, such as the audit committee. Reports are private
And for the directors and management of the company. Reports to the shareholders or members of a company on the truth and fairness of the accounts. Audit report is publicly available to the shareholders and other
Scope Work relates to the operations of the organization Work relates to the financial statements.
Relationship Often employees of the organization, although sometimes the function is outsourced. Independent of the company and its management. Usually appointed by the shareholders.
Planning and Collection of Evidence Strategic long term planning carried out, to achieve objective of assignments, with no materiality level being set. Some audits may be procedural, rather than risk-based. Evidence mainly from interviewing staff and inspecting documents (ie not external). Planning carried out to achieve objective regarding truth and fairness of financial
Statements. Materiality level set during planning (may be amended during course of audit).
External audit work is risk-based. Evidence collected using a variety of procedures per ISAs to obtain sufficient appropriate audit evidence.
Question 2 (LO 1) (20 marks)
ISA 300 Planning an Audit of Financial Statements provides guidance to assist auditors in planning an audit. What are benefits of audit planning? (5 marks)
You are an audit manager of Satsuma & Co and have been assigned to the audit of Tangerine Tech Co (Tangerine), a company which is planning to list on a stock exchange within six months. The listing rules of the stock exchange require compliance with corporate governance principles, and the directors are unsure whether they are following best practice in relation to this. They have asked the audit engagement partner for their view on this matter.
Tangerine’s board is comprised of six executive directors, a non-executive chairman and three other non-executive directors (NEDs). The chairman and one of the NEDs are former executive directors of Tangerine and on reaching retirement age were asked to take on non-executive roles. The company has established an audit committee, and all NEDs are members including the chairman who chairs the committee. All four members of the audit committee were previously involved in sales or production related roles.
All of the directors have been members of the board for at least four years. As the chairman does not have an executive role, he has sole responsibility for liaising with the shareholders and answering any of their questions. The company has not established an internal audit function to monitor internal controls.
Required: Using the information above: Describe FIVE corporate governance weaknesses faced by Tangerine Tech Co and provide a recommendation to address each weakness to ensure compliance with corporate governance principles. (15 Marks)
Benefits of audit planning
Audit planning is addressed by ISA 300 Planning an Audit of Financial Statements. It states that adequate planning benefits the audit of financial statements in several ways:
Helping the auditor to devote appropriate attention to important areas of the audit.
Helping the auditor to identify and resolve potential problems on a timely basis.
Helping the auditor to properly organise and manage the audit engagement so that it is performed in an effective and efficient manner.
Assisting in the selection of engagement team members with appropriate levels of capabilities and competence to respond to anticipated risks and the proper assignment of work to them.
Facilitating the direction and supervision of engagement team members and the review of their work.
Assisting, where applicable, in coordination of work done by experts.
(Students can write any 5 points – 1 mark for each)
Corporate governance weaknesses and recommendations
The board is comprised of six executives and only four non-executive directors (NEDs). There should be an appropriate balance of executives and NEDs, to ensure that the board makes the correct objective decisions, which are in the best interest of the stakeholders of the company, and no individual or group of individuals dominates the board’s decision-making. At least half of the board should be comprised of NEDs. Hence the board of Tangerine Tech Co (Tangerine) should consider recruiting and appointing additional independent NEDs to satisfy this requirement.
One of the NEDs and the chairman are former executive directors of Tangerine who were asked to take on their existing roles following retirement. As former executive directors, they were previously employed by the company and so may not bring the required level of independence and objective judgement to the role as is necessary. The independence of the other NEDs cannot be assessed. Only independent non-executives with relevant experience and skills should be appointed to the board of Tangerine. A review should be undertaken of the independence of all existing NEDs. Any who are not independent should ideally be replaced or supplemented by independent NEDs.
The chairman, who is a NED, sits on the audit committee as the chair. The audit committee is supposed to be made up of independent NEDs. The chairman can, for smaller companies, sit on the committee provided that he is an independent non-executive, which is not the case for Tangerine The chairman should cease to undertake the role of chair of the audit committee. One of the newly appointed independent NEDs should be appointed to this role instead.
All four members of the audit committee were previously involved in sales or production related roles. At least one member of the audit committee should have recent and relevant financial experience. None of the NEDs were former finance directors and so it is unlikely they possess the required financial experience. The company should ensure when they recruit the new independent NEDs that at least one of them has the required recent and relevant financial experience.
All of the directors have been members of the board for at least four years. The shareholders should review on a regular basis that the composition of the board of directors is appropriate, and that there is an appropriate re-election process in place to ensure this can be achieved The directors should be subject to re-election by the shareholders at regular intervals not exceeding three years. At the current year’s annual general meeting it should be proposed that a number of the directors are subject to re-election. The remaining directors could then be subject to re-election next year.
The chairman has sole responsibility for liaising with the shareholders and answering any of their questions. However, this is a role which the board as a whole should undertake. All members of the board should be involved in ensuring that satisfactory dialogue occurs with shareholders, for example, all should attend meetings with shareholders such as the annual general meeting. The board should state in the annual report the steps they have taken to ensure that the members of the board, and in particular the non-executive directors, develop an understanding of the views of major shareholders about the company.
Currently Tangerine has not established an internal audit function. The audit committee should consider the effectiveness of internal controls and internal audit could support this role. Where there is no internal audit function, the audit committee is required to annually consider the need for one. Further consideration should be given to establishing an internal audit function. Having an internal audit function will help the audit committee to discharge their responsibility for monitoring internal controls. However, the costs of establishing an internal audit function should be considered against the benefits to be gained.
(Students can write any 5 points – 3 marks each)
Question 3: (LO 1 and LO 3)
Describe FIVE types of procedures for obtaining audit evidence.
For each type of procedure, describe an example relevant to the audit of BANK balances.
Quartz’s finance director has asked your firm to undertake a non-audit assurance engagement later in the year. The audit junior has not been involved in such an assignment before and has asked you to explain what an assurance engagement involves.
Explain the five elements of an assurance engagement.(5 Marks)
Procedures to obtain evidence and an audit test relevant to bank balances
Inspection involves examining records or documents, whether internal or external, in paper form, electronic form, or other media, or a physical examination of an asset.
Inspect the bank reconciliation for any outstanding lodgements and agree to the pre year-end cash book, post year-end bank statement and also to paying-in-book pre year end.
Observation consists of looking at a process or procedure being performed by others.
Observe the process for the opening of mail and logging of any cheques received from customers to ensure adequate segregation of duties.
Analytical procedures consist of evaluations of financial information through analysis of plausible relationships among both financial and non-financial data. Analytical procedures also encompass such investigation as is necessary of identified fluctuations or relationships which are inconsistent with other relevant information or which differ from expected values by a significant amount.
Review the year-end bank balance against prior year to identify any significant fluctuations as these could be evidence of window dressing and discuss with management.
Inquiry consists of seeking information from knowledgeable persons, both financial and non-financial, within the entity or outside the entity
Inquire of management as to whether the company has opened/closed any bank accounts during the period.
Recalculation consists of checking the mathematical accuracy of documents or records. Recalculation may be performed manually or electronically
Recalculate the additions in the year-end cash book to confirm accuracy of the amount.
An external confirmation represents audit evidence obtained by the auditor as a direct written response to the auditor from a third party, in paper form, electronic form or by other medium.
Obtain a standard bank confirmation from each bank the company has undertaken banking transactions with during the year.
Re-performance involves the auditor’s independent execution of procedures or controls which were originally performed as part of the entity’s internal control.
Re-perform the year-end bank reconciliation to ensure the process was undertaken accurately.
Elements of an assurance engagement (5 Marks)
In accordance with ISAE 3000 Assurance Engagements other than Audits or Reviews of Historical Financial Information, an assurance engagement will require a three-party relationship comprising of:
The intended user who is the person who requires the assurance report.
The responsible party, which is the organisation responsible for preparing the subject matter to be reviewed.
The practitioner (i.e. an accountant) who is the professional who will review the subject matter and provide the assurance.
A second element which is required for an assurance engagement is suitable subject matter. The subject matter is the data which the responsible party has prepared and which requires verification. Thirdly this subject matter is then evaluated or assessed against suitable criteria in order for it to be assessed and an opinion provided.
Fourth, the practitioner must ensure that they have gathered sufficient appropriate evidence in order to give the required level of assurance. Last, an assurance report provides the opinion which is given by the practitioner to the intended user.
Question 4: (LO 1 and LO 3)
You are an audit manager of Pink Partners & Co (Pink) and are planning the audit of Golden Finance Co (Golden), a banking institution which provides a range of financial services including loans. Your firm has audited Golden for four years and the company’s year-end is 30 September 2015.
At the end of August, Golden’s financial controller left and the new replacement is not due to start until approximately two months after the year end. The finance director, who is the sister-in-law of the audit engagement partner, has asked if a member of the audit team can be seconded to Golden for three months to act as the temporary financial controller.
You are aware that a number of the audit team members currently bank with Golden and two team members have significant loans owing to the company.
Pink’s taxation department also provides services to Golden. They have been approached by Golden to represent them in negotiations to resolve some outstanding issues with the taxation authorities, for which the fees quoted are substantial.
The finance director has informed the audit engagement partner that when the audit is complete, she would like the whole team to attend an evening watching the national football team play a match followed by a luxury meal.
Required: Using the information above:
Identify and explain FIVE ethical threats which may affect the independence of Pink Partners ; Co’s audit of Golden Finance Co; and (10 Marks)
For each threat, explain how it might be reduced to an acceptable level. (5 Marks)
Discuss the following situations in the context of the independence of the auditor, showing clearly
The audit manager in charge of the audit assignment of Andrew Co holds 1,000 $1 ordinary shares in the company (total shares in issue – 100,000). The audit partner holds no shares.
The audit fee receivable from Janet Co, a private company is $100,000. The total fee income of the audit firm is $700,000.
The audit senior in charge of the audit of Margot Bank Co has a personal loan from the bank of $2,000 on which she is currently paying 13% interest.
The audit partner is responsible for two audit assignments, Harry Co and Jean Co. Harry Co has recently tendered for a contract with Jean Co for the supply of material quantities of goods over a number of years. Jean Co has asked the audit partner to advice on the matter.
Answers to Q4:
Ethical threats and managing these risks
Ethical threat Managing these risks
The finance director is the sister-in-law of the audit engagement partner and hence there is a family relationship. There is a familiarity and self-interest threat as the audit partner and the finance director both hold senior positions and therefore are in a position to influence the outcome of the audit. There is a concern that they may place their family relationship above the needs of the users of the financial statements Although the family relationship is only established by marriage, as it is a sister-in-law, it would be advisable for the audit engagement partner to be removed and an alternative partner appointed.
Golden Finance Co’s (Golden) finance director has asked if a member of the audit team can be seconded to fill the role of financial controller. A self-review risk arises if the team member prepares records and schedules which support the financial statements and is then part of the audit team responsible for auditing these. Pink Partners ; Co (Pink) should clarify exactly which areas the seconded team member would assist Golden on. Though it is likely that as the financial controller, the team member will be directly involved in dealing with items related to the financial statements. As such, the request from the finance director should be politely declined, or the team member should be removed from the audit of Golden.
Two members of the audit team have significant loans owing to the company. Golden is a banking institution and hence the provision of a loan is within the normal course of business. The terms of the loans should be reviewed to ascertain whether they are in any way preferential. If not, no further action is required.
The finance director has invited the whole team to attend an evening out watching the national football team play a match followed by a luxury meal. This represents a self-interest and familiarity threat as the acceptance of goods and services, unless insignificant in value, is not permitted. As it is unlikely the football tickets and luxury meal for the whole team has an insignificant value, then this offer should be politely declined.
However, if either of the loans has any preferential terms, such as rates or repayment periods, then this would represent a self-interest threat. However, if the terms are preferential then either the terms should be amended or these two members should be removed from the audit team.
The taxation fees being quoted to Golden are substantial. There is a potential self-interest threat as the total fees could represent a significant proportion of Pink’s income and the firm could become overly reliant on Golden. Pink should assess whether audit, non-audit and total taxation fees would represent a significant proportion of recurring fee income. If the recurring fees are likely to be significant, additional consideration should be given as to whether the taxation and/or non-audit assignments should be undertaken by the firm.
(Students can write any 5 points and 3 marks for each )Independence on the part of the auditor as a reporting accountant is seen by many to be a fundamental concept of auditing. It has been said that it would never be sufficient for an auditor to claim that he was independent. In fact, he must always be clearly seen to be independent in practice. Given this situation, it would be almost impossible to draw up a set of rules to cover every conceivable situation where an auditor’s independence might be called into question. Whilst not able to provide an exhaustive list of recommendations, the main principles which should be applied when considering the question of independence may be found in the relevant section of the ACCA’s Code of Ethics and Conduct. With this in mind, the following comments could be made in relation to the situations specified in the question:
The audit partner has no shareholdings in the client company and so, all other things being equal, he could be seen as giving an objective audit opinion. However, the audit manager does have a shareholding in the client company which, whilst not material to the company (at 1% of issued share capital), could be material to the audit manager and certainly might be seen to influence his ability to give an impartial opinion in relation to the company’s affairs. As the partner will inevitably have to rely upon the work completed and controlled by the audit manager it is clearly undesirable for the manager to have such a financial involvement in the client’s affairs.
The code suggests that under normal circumstances no more that 15% of the gross fee income of a practice should come from any one client source. The reason for this is that the fear of losing a major client, and thus a substantial proportion of fee income, could prejudice the auditor’s objectivity and make him more likely to bow to pressures from the client.
The audit fee from Janet Co contributes some 14.3% of the total fees income of the practice and so is within the 15% recommended limit. It would be necessary to consider whether any other fee income was received from this client, as this could result in the 15% limit being exceeded. However, perhaps the most important point to note is that the 15% is merely a guide. If the figure is slightly exceeded it does not automatically mean that independence is impaired and it must also be appreciated that even if the level of fee income is below 15% the auditor’s independence could still be seen as being prejudiced. The firm would need to keep this situation under constant review.
As another instance of where financial involvement in a client’s affairs could be seen to impair an auditor’s objectivity, the code recommends that between an auditor and a client, there should be no loans or guarantees in respect of loans either way. Any such financial involvement could be seen to impair the auditor’s judgement either because of a client putting pressure on the auditor or because of the auditor’s own fear of suffering some financial loss.
However, the code does allow for one exception in making the above recommendation and that is where the loan is ‘in the normal course of business and on normal commercial terms’, providing it is not to the engagement partner (i.e. allowed for other audit staff members and practice partners). It is part of a bank’s normal business to make personal loans and if the rate of interest being paid by the audit senior is the normal commercial rate of interest, this transaction is unlikely to be seen as impairing the auditor’s independence.
The code also considers the problems that can be created when conflicts of interest arise between different clients and between clients and the auditor’s own business interests. It concludes that every effort should be made to avoid conflicts of interest arising and that it would be highly unethical for an accountant to act in a situation where he knew that a conflict of interest existed. The situation described in the question is a good example of the type of conflict of interest with which the code is concerned. The audit partner should not advise Jean Co with regard to the contract tender received from Harry Co. The auditor should explain the professional reasons why he is unable to act on this occasion and suggest that Jean Co seek advice from another firm of accountants.