MGAD10 Case Assignment 1 Case Question

HW & KH Fall 2014

You, CPA, CA/CGA/CMA, are an auditor at a large public accounting firm. Shortly after
receiving your professional designation, you were approached by the President of your
Provincial Institute about joining the Professional Conduct Committee (PCC) as a
volunteer investigator.
The PCC is responsible for investigating potential breaches of the rules that govern the
conduct for auditors of financial statements (i.e. Rules of Professional Conduct and the
Canadian Auditing Standards). After each review, the PCC is responsible for making
recommendations regarding whether the Discipline Committee should proceed to further
investigations and/or a hearing which will determine whether members have in fact
breached the rules. Furthermore, they are expected to provide recommendations to the
individual or firm as to how they can ensure they do not breach the rules in the future.
You thought this sounded like an interesting opportunity and you agreed to join the PCC.
At the January 4, 2014 PCC meeting, you were assigned to investigate two complaints
made against Bill Spence (Spence), a partner at Guthy, Halbert, Spence LLP (GHS
LLP). The PCC Chairperson asked you to investigate the complaints and prepare a
report to the PCC regarding whether there is merit to the allegations. He asked that you
make a conclusion about whether or not the complaints should be referred to the
Discipline Committee for a hearing. The Chairperson provided you with information
regarding Spence (Exhibit 1) and details of the complaints (Exhibit 2). Given your
experience with a large public accounting firm and the notes hes gathered from a
previous investigator (Exhibit 3), he questions whether or not the working papers were
conducted in accordance with CAS and would like to consider if this should be raised
with the Canadian Public Accountability Board (CPAB).
Before starting your investigation, you confirmed that there are no conflicts of interest as
you have no relationship with Spence, GHS LLP or the clients involved. The
investigation began on January 10, 2014 when you and the other investigator assigned
to these complaints met with Spence.
Required:
Prepare the memo requested by the quality control committee partner.
Page 1 of 5
Exhibit 1Information about Bill Spence, Public Accountant and GHS LLP
Bill Spence, Public Accountant
HW & KH Fall 2014

In 2000, Spence graduated with a business degree and began

working at a big public accounting firm. He later passed his accounting professional
exams and began working his way up in the firm. Spence knew at the very beginning he
wanted to be a partner at the firm. In 2007, Spence requested to be put on the partner
track at the firm but the request was not granted. As a result, in the Fall of 2009, Spence
began his employment at GHS LLP with an agreement that he would be made partner
within five years.

Spence was originally hired as a senior manager and was given

some of GHS LLPs larger clients. Determined to get partnership, Spence took part on
various special projects that included improving the firms productivity and was also the
Team Senior Manager of the office. Pleased with his performance in the first three years
at the firm, the existing partners at GHS LLP signed an agreement with Spence to make
him a partner by the Fall of 2013 pursuant to certain terms as stated in the agreement.

The plan was for Spence to take over one of the founding partners clients as she was
planning to retire in 2013.

On September 1, 2013, Spence was admitted to the GHS LLP

partnership by purchasing the retired partners interest. As a means of announcing this
change at the firm, GHS LLP ran several newspaper advertisements describing Spence
and his experience as well as congratulating him for his successful admission into the
partnership. These advertisements ran in October 2013. GHS LLP

GHS LLP is a medium-sized firm that provides a complete range of

assurance, advisory and taxation services. The firm has been relatively successful and
has grown from three independent small-sized firms to one of the largest mid-size firms
in Mississauga, Ontario.

GHS LLP has felt in the last 3 years challenges with a growing
payroll. Theyve begun outsourcing simple audit tasks to India as a way to bring down
payroll costs. Spence is the lead partner which took this initiative to help the firm improve
its productivity and reduce costs.
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Exhibit 2Details Regarding the Complaints against GHS LLP
Audit of Titans of DR Inc.
HW & KH Fall 2014

Titans of DR (TDR) is a company who specializes in being the

exclusive dealer to 80% of private schools across Canada for school uniforms. TDR
manufactures, fulfills and distributes to these schools. As specific partnership with these
schools, TDR pays a commission that ranges from 10-15% to the school for every
uniform that students purchase.

On November 11, 2013, the PCC received a written complaint from

the new private equity investor Rosewood Equity (the new owner of TDR) regarding the
companys audit for the year ended August 31, 2013. In the letter, John McIntyre
(Partner of Rosewood Equity) alleged the following:
o In 2013, GHS LLP became the new auditors for TDR and Spence was the partner on
the audit. He found it odd that he did not contact the predecessor auditors before
accepting the engagement. However, Spence assured him that he was not required to
do so since GHS LLP does the taxes for Rosewood Equity and thus he was not required
to do so.
(Rules of professional conduct 302/303 Predecessors)
A member or firm cannot accept an engagement without first communicating with the
predecessor enquiring whether there are any circumstances that should be taken into
account which might influence the decision whether or not to accept the engagement
The predecessor is required to respond promptly
The clients consent is not required for the communication to take place but is
required for the predecessor to speak freely OK
o Since John was focused on finding suitable companies for TDR to grow through
acquisition and find financing, he did not follow up on the matter.
o However, when he saw a publication posted by CPA magazine about contacting
predecessor auditors, he wanted to look into this further and realized it may be
something the PCC would be interested in hearing
o When John expressed his concerns to TDRs CFO, the CFO confided that he thought
the audit was completed too quickly, especially due to all the changes that have
happened in the company (may relate to their pressure on payroll so the firm had to cut
cost by spending fewer hours)

Anonymous Complaint

An anonymous whistleblower sent a fax to the PCCs Chairperson on

November 13, 2013 regarding the conduct of Spence. The fax stated that the PCC
should investigate the April 2013 invoice to Crackle Consulting Ltd. (CCL) and the
related payment. The anonymous whistleblower suggested that Spence allowed Crackle
Consulting to write two cheques to settle the invoice: one cheque to the firm and the
other to Spence himself (in the amount of $3,000).
(Relate to the second last point on page five, most likely CCL was told by Spence to
prepare two cheques and he personally took the $3000 thus writing it off on the firms
book. According to Rules of professional conduct 204 Independence, objectivity is hard
to prove when the PA personally benefit from a client due to a financial interest from a
client. Not only a PA must be indepent in fact, he/she must also appear to be
independent to others. receiving $3000 to Spence personally clearly violates this rule.)
OK

The anonymous whistleblower has mentioned that they have been

getting a lot of complaints by schools for being underpaid on their school commissions in
the year and not sure why when the payment was based off of the calculated
spreadsheets which matched the financials (The commission is mysteriously missing?
Fraud may be involved in this case:
Auditing Standards: CAS 200
To obtain reasonable assurance about whether the financial statements as a whole
are free from material misstatement, whether due to fraud or error in order to express
his/her opinion on the financial statements)
CAS 240 The Auditors Responsibilities Relating to Fraud in an Audit of Financial
Statements
_ Requires that an auditor must assess the risk of material misstatement due to fraud
_ Professional skepticism
_ Fraud triangle
_ Incentives / Pressures to Commit Fraud
_ Opportunities to Commit Fraud
_ Attitudes and Rationalization to Justify a Fraud
Criminal Liability
If the auditor is found guilty of fraud, the auditor can be sued criminally To prove
fraud, the auditor must be shown to have knowingly made a false assertion OK

Furthermore, PCC was asked to investigate a site BADV.com a

site that sells business intelligence information. As one of the previews in the intelligence
packages shows unique agreements that looked coincidentally similar to those that TDR
has recently signed. When looking back, the anonymous whistleblower suggested that
TDR has yet to have received any of their working papers back since the release of the
audit report.
(In fact, there is no rules for clients to receive the working papers back. However,
according to Rules of professional conduct 208 Confidentiality, a firm shall not
disclose any confidential information concerning the affairs of any client, former
client, employer or former employer unless the information certain requirements are
met, for instance, used as evidence in the court or communication with predecessor
accountants. Also, according to CAS 230 Audit Documentation, it requires an auditor to
document each stage of its audit in their working papers to provide a record of work, and
the working papers are the property of the firm. The firm must also retain them for a
certain period of time. There might be a potential breach of confidentiality however we
do not have any powerful evidence that shows GHS is involved in this issue. Not
returning the working paper should not be considered as an evidence.) ok

A mysterious fax to the PCC suggested a review some of the larger round number
cash deposits in Spences personal bank account for the period of June to August 2013
(relates to the last point on page 5, the money Spence used to purchase the shares of
his firm were returned to him. It depends on who deposited the money in his bank
account. If it was a client, then this is definitely not allowed under Rule 204
independence, receiving financial interest hence causing it difficult to prove objectivity.)
OK
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Exhibit 3Chairpersons Review Notes from Investigator
Review of Titans of DR Inc. (TDR) Working Paper Files
HW & KH Fall 2014

Audit Planning. We noticed that the planning section of the audit was
relatively well done for a first time engagement and the aspects of the acquisition.
However, in the understanding of internal controls, we noted that there was no mention
or thought given to changeover in management. Based on our understanding, the
previous owner of TDR decided to retire and sell the company to Rosewood Equity. As
part of their investment strategy, they take a critical assessment of top management. As
a result of their assessment, all of top management including the controller was
replaced. All of these changes were part of the companys objective for a fresh start.
(According to the stages of audit and CAS 315, in the preliminary risk identification,
auditors are required to understand the entity and environment, including internal
controls of the firm that is being audited. In fact, the previous owner replaced all
controllers and the motive of such an action is highly suspicious. The partner did not
impose professional scepticism in this situation as there is a high turnover of key
employees.)

While reviewing the files, I noticed that the audit was primarily
substantive in nature since GHS had decided to not test financial statement controls.
However, I didnt notice any section of the working papers dedicated to gaining an
understanding of Internal Control. The conclusion in the file stated that It was more
efficient to approach the audit using a substantive approach. Its unlikely the internal
controls would be broken given the upgrade in talent for management especially with
designated accountants and since the Controller, who use to sign the cheques for
payment is no longer with the company, we cant ask him questions TDRs files
contained working papers documenting the results of its substantive testing. Each
section of the work contains a checklist of substantive tests. The tests appear to have
been developed specifically for this engagement. The steps on the checklists also
appear to have been signed off and cross referenced to the appropriate working papers.
This seems to have assured that all procedures designed were completed as well as
ensuring that procedures were performed for each of the major accounts in the Financial
Statements. (Using substantive approach may also gain an understanding in internal
control as it is required under the stages of audit and CAS 315, in the preliminary risk
identification, auditors are required to understand the entity and environment, including
internal controls of the firm that is being audited. After the level of internal control is
identified, the auditor may decide which approach to use and the reliance on substantive
procedures. Auditor should not jump to the conclusion that internal controls wont be
broken. Also, under CAS 500, evidence-gathering procedures, auditors should gain an
understanding of the client and to corroborate other evidence gathered throughout the

audit and auditor should draw a conclusion based on the existing documents, instead of
giving up due to the termination of the former employees. OK

Memo on Planning. A short memo sets out that the audit will be fully
substantive against a materiality of $370,000 and follow the approach used in the
previous years audit. Performance materiality was set with a haircut of 25% to
$277,500. (CAS 320, Materiality in Planningand Performing an Audit, requiresthe auditor
to determine materialityfor the financial statements as a whole and performance
materiality. Performance materiality means the amount or amounts set by the auditor at
less than materiality for the financial statements as a whole to reduce to an appropriately
low level the probability that the aggregate of uncorrected and undetected
misstatements exceeds materiality for the financial statements as a whole. Usually it is
25% to 50%. More information is required for us to determine if the materiality is
sufficient. But the haircut level is reasonable.) OK

Acquisition/Purchase Price Accounting. All aspects of the purchase

price accounting was properly accounted for under IFRS3 and supported in accordance
to CAS. (IFRS is absolutely acceptable, but it my also utilize the ASPE.) OK

Accounts Receivable. The audit work in this section included a

confirmation of 5 of 50 accounts receivable balances that covered 97% of the entire A/R
balance $6,146,000). No further work was performed concluding that materiality is
$277,500 so no further work was performed. There was no evidence gathered related to
the collection of payment for A/R made by customers after year end. The conclusion was
stated since we confirmed 97% of the A/R balance, theres no need to verify payments.
The auditor is obviously conducting an audit with deficiencies, as there is a substantive
testing of account receivables. I do see that the auditor conducted testing on the
existence assertion of the A/R however he did not provide any assurance as to whether
the client will recover all of the balances. (pg 393) The best way to ensure the balance is
by the full receipt of the cash by the clients after the year-end. Additional tests may be
referred to as subsequent receipts, where a sample of A/R at year end is vouched to the
subsequent receipt of cash from the customer.

Bank indebtedness. This amount was confirmed by the bank. The

auditors also noted that this amount had significantly increased from prior year and
explained that it was due to the large increase in accounts receivable which would be
collected after year end. Referring to CAS 505, it is classified as a bank confirmation.
The persuasiveness of audit evidence is depended on its source and the bank should be
classified as creditworthy. Accordingly CAS 520, auditor should conduct analytical
procedures which includes trend analysis. The auditor was able to do so by comparing
the results from the previous year, however the analysis lacked the information on the
reason of the increase of the A/R.
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HW & KH Fall 2014

Inventory. The audit work in this section included investigating the

warehouse shipping and receiving logs two weeks before and after year end. The
complete log was included in the file and it was noticed that the duration of 1 week was
completed before and after year end. A review of the receiving logs includes inventory of
$500,000 that was received before August 31st but not recorded in the system. The
conclusion was that since it was not in the system, its in the right accounting period.
(Insufficient audit procedure and unprofessional judgement. An auditor must utilize their
judgement and to determine the reliability of the information. The investigation is to
include two weeks before and after year end but the log is only one week before and
after year end. In other words, the log cannot cover the two-week period. On the other

hand, the inventory received before august 31st is NOT in the right accounting period as
it should be included in the fiscal year. It generates an impact on the financial statement
because it understates the inventory.)

Fixed Asset. The company spent $800,000 on repairs and

maintenance this year where last year the repairs and maintenance for last year was
$200,000. The note explains that the company has accountants with designations so its
pretty clear they know what is capital vs. expense. Amount is accurate. No further work
performed. (CAS 240 The Auditors Responsibilities Relating to Fraud in an Audit
of Financial Statements
_ Requires that an auditor must assess the risk of material misstatement due to fraud Professional scepticism. The auditor did not hold processional scepticism against the
behaviour of the accountants. According to CAS 520, auditor should conduct analytical
procedures which includes trend analysis. The auditor should conduct a more thorough
trend analysis to determine if the expenses should be capitalized or not.)

Accounts Payable. It was noticed that the work performed for

payments after year end was completed only up until September 5th. The conclusion
that was written was The business operates 24/7 so all cheques in the period would be
cleared by then This should not be considered as an issue because most cheques are
cleared within one to three business days. Up until September 5th is reasonable to
include the payments that are accountable for this fiscal year. Should there is any
cheque that is cleared after September 5th that should be included in this years balance,
then an adjusting entry would e needed.

Revenue. I noticed that no additional procedures were performed on

revenue despite the fact that it had almost doubled year-over-year. Accordingly CAS
520, auditor should conduct analytical procedures which includes trend analysis. And
according to CAS 315, the auditor should also understand the client based on different
aspects, for example: entity level, industry level and economy level to examine whether
the revenue matches with those conditions.

School commissions payable was in a debit balance. School

commission expense was significantly lower than the prior year despite minimal changes
to them. The rates used to calculate commissions did not match the agreement with the
schools. The conclusion in the file was the difference in the rate is immaterial. This
relates to one of the points that the whistleblower mentioned. The commissions that the
schools received did not match with the agreement. Firstly, an account payable with a
debit balance is already a signal of scepticism and red flag should be placed. The
auditor failed to provide due care in this case because the difference is not immaterial as
there is a big difference than the prior year. Again, CAS 520, auditor did not conduct
trend analysis thoroughly. OK

Final Analytics was performed and completed by the Team in India. In

the analytics, it looked identical to the Planning analytics with no discussion of insights
coming from the performance of the audit. A review note was found still remaining in the
audit file by Spence Just let India do the Final Analytics, we need to save costs as were
already over budget on our engagement already. The quality of work being done
overseas might be unreliable. However, many accounting and law firms often outsource
simple tasks overseas to cut costs and thats Spences intention. Though, according to
ROPC 200, all auditors must provide due care to the client and serve public interest.
These analytics from India clearly cannot provide due care to the client because
evidently no work has been done.

Review of Board of Directors Minutes. Minutes from the Board of

Directors meetings were included in the file that was reviewed by the Junior Associate.

The Junior Associate wrote No issues identified. This was signed off by the Associate
and no other reviews from senior individuals of the team.. Accordingly to CAS 501 Audit
evidence specific considerations for selected items, it requires auditors to gather
sufficient appropriate audit evidence regarding any legal matters involving the client, and
Board of Directors Minutes is one of the documents included. If there is any legal
concern raised, a legal letter will be sent to the law firm to confirm the details of the legal
matters. In this case, there is no problem for the Jr. Associate and Associate to review
the minutes, as long as there is no legal concerns in these minutes. However, I think
Spence or a senior partner should also review the minutes to ensure there is no legal
issues.

Audit Communication Letters. We noted that all required

communication letters were obtained and appropriately included in the working paper
files. GOOD
Other Evidence

Spence provided the invoice to CCL and the related documents

showing the cash receipts. The files show that $3,000 was written off at the beginning of
August because the client was not able to pay the full amount of the invoice. This was
the only explanation and it was provided by a handwritten note from Spence. The
remaining amount of the invoice had been paid in July. When we enquired about past
collections from CCL, we noted that CCL has always paid on time and has never had
issues paying their invoices. REFER TO POINTS ABOVE OK

Spence provided his monthly bank statements from June to August

2013. Interestingly, there are several round dollar amounts that were deposited that did
not relate to his salary at the firm. However, the total of these suspicious deposits equal
the amount that Spence paid on September 1, 2013 for the retiring partners interest in
GHS LLP. OK
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