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AUD 610/560
SUGGESTED SOLUTION
APR 2010
QUESTION 1
A. (i) Confidentiality
A member must be fair and must not allow prejudice or bias or influence of others
to override his objectivity. Objectivity is the state of mind, which has regard to all
considerations relevant to the task in hand but no other.
Under certain circumstances, laws and regulations give the auditor a duty to
report to a regulator or public authority on matters which are deemed to be of
‘public interest’ and which may need to be investigated by the regulator or
authority.
Examples include:
Reporting direct to regulators such as the Bank Negara Malaysia or Bursa
Malaysia on regulatory breaches in respect of financial service and
investment businesses;
The reporting of suspected money laundering to the authority such as the
police.
In making such a report, an auditor is not deemed to have broken the confidence
of the client.
Money laundering is the process whereby money is gained illicitly e.g. through
terrorism, robbery is made ‘clean’; fund is moved through a number of different
bank accounts.
(4 marks)
C.
(i) In Kingston Cotton Mill Co. (1896) it was established that an auditor has to perform that
skill, care and caution which a reasonably competent, careful and cautious auditor would
use. What is reasonable skill, care and caution must depend on the particular
circumstances of each case. Generally, an auditor can be said to have exercised due
care if he follows the requirements of the auditing standards.
In the case of Prospek Teguh, the auditor had encountered a major internal control
deficiency. However, the matter was not highlighted to the top management. Further,
there was no evidence that the auditor had carried out additional audit procedures in
order to determine the impact of the internal control weakness on the truth & fairness of
Prospek Teguh Sdn Bhd’s financial statements. As such, there is a strong possibility that
the auditor has not exercised due care in the performance of the audit.
(4 marks)
(ii) Based on privity of contract, Oct Bank is a third party that should not have relied on the
auditor’s report because the audit report was issued to the shareholders in accordance
with the statutory requirements.
It may also be argued that the auditor is not responsible for internal control weakness
and detection of fraud. In London and General Bank (1895), it was established that an
auditor does not guarantee that the books do correctly show the true position… He does
not even guarantee that the balance sheet is accurate.
If legal action is initiated by Oct Bank, the following conditions might need to be tested
before auditor’s liability is determined: Duty of care is owed to plaintiff, the audit is
negligently performed, plaintiff has suffered a loss and the loss is quantifiable. In this
case, there is a strong possibility that the auditor has not exercised due care (as
explained in Q1(ii)). However, whether the auditor owes duty of care to the plaintiff is
another issue that needs to be addressed.
Principles established from other cases suggested that an auditor might also be held
responsible to third parties. For instance, in Ultramares Corporation v. Touche Niven &
Co (1931), it was established that if liability for negligence exists, a thoughtless slip or
blunder, the failure to detect a theft or forgery beneath the cover of deceptive entries may
expose accountants to a liability in an indeterminate amount for an indeterminate time to
an indeterminate class. In Candler vs. Crane, Christmas & Co (1951), accountants owe
a duty to their employer or client and also to any third person to whom they themselves
show the accounts, or to whom they know their employer is going to show the accounts
so as to induce him to invest money…
In Hedley Byrne & Co vs Heller & Partners (1963), it was established that auditor’s
liability to third party is similar to their liability to clients. The absence of a contract did
not constitute a valid defense. Further, in JEB Fasteners Ltd v. Marks, Bloom & Co
(1981) the court held that when there is sufficient degree of proximity or neighbourhood,
a duty of care is owed to the third party. Auditor has liability to any foreseeable party that
might suffer losses arising from reliance on the audited accounts.
Similar principle was supported in Twomax Ltd v. Dickson. McFarlane & Robinson (1983)
case whereby it was established that when reliance on the accounts is foreseeable, a
duty of care is owed to the third party.
Nevertheless, based on Caparo Industries Pty. Ltd. V Dickman (1990), auditors owed no
duty of care to the public at large, who relied upon the accounts in making investment
decisions. Accordingly, it may however be argued that the auditor does not owe duty of
care to Oct Bank because it is not a party in the engagement.
(Citing of any relevant 4 legal cases to earn 8 marks)
(Total: 20 marks)
QUESTION 2
A. (i) The various factors in the accounts which may be indicative of going concern
problems are:
Losses or low profits only being made
Increase in bank overdraft
Signs of overtrading
High and increasing gearing
Low current ratio
Low and decreasing liquidity ratio
Increasing stock levels
Increasing value and age of creditors
High and increasing interest charges
Fluctuating gross profit
(Any 6 for 3 marks)
(ii) The procedures to be performed in determining whether or not the company may be
properly regarded as a going concern at year end include:
Reviewing carefully the cash and profit forecasts for the next year to see if they
suggested any improvement in the company’s position
Seeking some evidence that the company’s bank is prepared to continue
supporting the company
Review the level of post balance sheet trading to see if this supports the
forecasts and show any signs of improvement in the company’s position
Examine correspondence files for any evidence that creditors might be putting
pressure on the company for repayment of amount owing
Consider how the company’s position compares with similar companies in the
same business
Generally discuss the situation with management and review any recovery plans
which they have in mind
Read minutes of the meetings of shareholders, the board of directors and
important committee for reference of financing difficulties.
(5 marks)
(iii) Modified report- that do not affect the auditor’s opinion: emphasis of a matter.
(Should be presented after the opinion paragraph)
Without qualifying our opinion, we draw attention to Note X to the financial statements.
The Company incurred a significant net loss during the year ended 30 September 2007
and as of that date the company’s current liabilities exceeded its current assets. These
factors raise substantial doubt that the Company will be able to continue as a going
concern.
(4 marks)
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A. (i) Auditors’ responsibility extends to the date on which they sign the audit
report. As this date falls after the year end, it follows that in order to discharge
their responsibilities and avoid any liabilities, the auditors must extend their
audit work to cover the post balance sheet events.
Reviewing the post balance sheet period enables the auditor to ascertain
whether management has dealt correctly with any events, both favorable and
unfavorable, which occurred after the year end and which need to be
reflected in the financial statements, if those financial statements are to show
true and fair view. (i.e. adjusting and non adjusting events)
(ii) During this period the auditor has no obligation to make any enquiry about
whether any material subsequent events have occurred. However, if the
auditor becomes aware of a material subsequent event within this period, he
should consider whether he should withdraw his audit report. He will probably
have to take legal advice on the matter. Also, he should discuss the problem
with the company. It may be necessary for either the directors or the auditors
to make a statement at the annual general meeting.
If the directors revise the financial statements, the auditor will have to audit
these revisions and come to a conclusion on whether the revised financial
statements show a true and fair view. The audit report on the revised financial
statements should have an explanatory paragraph which refers to the note to
the financial statements which describes the changes, and it should refer to
the earlier audit report. The audit report on the revised financial statements
should have a new date and not be dated before the date the directors
approve those financial statements.
If the directors do not revise the financial statements, and do not make a
statement at the AGM, the auditor should notify the company’s management
(usually directors) that action will be taken to prevent reliance on the auditor’s
report. The action taken will depend on the auditor’s legal rights and
obligations and the recommendations of the auditor’s lawyers. This will
include the possibilities of the auditor making a statement at the AGM.
(6 marks)
(Total: 20 marks)
QUESTION 3
A. (i) Fraud: Intentional act by one or more individuals among management, those
charged with governance, employees or third parties, involving the use of
deception to obtain unjust or illegal advantage. Examples include:
a. The work has been performed in accordance with professional standard and
regulatory and legal requirements.
b. Significant matters have been raised for further consideration.
c. Appropriate consultations have taken place and the resulting conclusions
have been documented and implemented;
d. There is a need to revise the nature, timing and extent of work performed.
e. The work performed supports the conclusions reached and is appropriately
documented.
f. The evidence obtained is sufficient and appropriate to support the auditor’s
report; and
g. The objectives of the engagement procedures have been achieved.
(1 mark for any acceptable point, 4 x 1 = 4 marks)
(Total: 20 marks)
QUESTION 4
A. (i) When the auditor is in situation where he believes that there is a high exposure to
legal liability, the acceptable audit risk would be set lower than when there is a
little exposure to liability and vice-versa. Even when the auditor believes that
there is little exposure to legal liability, there is till a minimum acceptable audit risk
that should be met.
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(3 marks)
(ii) Two examples of situations that could lead to financial statements being
misstated:
a. Misapplication of applicable accounting standard.
b. Departure from fact, or omissions of necessary information.
(2 marks each for any acceptable point with explanation)
(4 marks)
(iv) If IR and CR are assessed as high, the auditor has to ensure a low DR level
by setting a low materiality level and accumulating more evidence from
substantive procedures and vice versa.
(3 marks)
B. CIS
(i) Audit software: computer programs used for audit purposes to examine the
contents of the client’s computer files.
Test data: data used by the auditor for computer processing to test the operation
of the enterprise’s computer programs.
Benefits include:
o By using the computer program, the auditor can scrutinize large volumes of
data and concentrate skilled manual resources on the investigation of results,
rather than on extraction of information.
o Once the program have been written and tested, the costs of operation are
relatively low, indeed the auditor does not necessarily have to be present
during its use.
b. If the auditor needs to report within a comparatively short of time scale, using
CAATs would then be more efficient because they are quicker to apply, even
though manual methods are practicable and may cost less.
c. The auditors also need to consider whether CAATs and the required computer
facilities, computer files and programs are available. In addition, since many
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QUESTION 5
A. Four (4) matters that can be considered by the two parties mentioned above.
(i) Nature of the engagement including the fact that neither an audit nor a review
can be carried out and accordingly no assurance will be expressed.
(ii) Fact that the engagement cannot be relied upon to disclose errors, illegal acts
or other irregularities.
(iv) Fact that mgmt is responsible for the accuracy & completeness of the info
supplied for completeness & accuracy of the compiled financial information.
(v) Basis of a/c on which the financial information is to be compiled, and the fact
that it, any known departures there from, will be disclosed.
(ii) Auditor is responsible to examine and report on the PFI to enhance its credibility
whether it is intended for use by third parties or for internal purposes.
(2 marks)
(iii) An auditor should consider withdrawing themselves from any engagement involving
prospective financial information (PFI) when, either:
a. Auditor believes that the presentation & disclosure of the PFI is not adequate.
Eg: Financial Information fails to disclose adequately the consequences of
any assumptions which are highly sensitive; or
C. (i) Four (4) procedures that would normally be performed by auditor before any
report on the review of client’s financial statement (FS) can be issued.