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CONFIDENTIAL 1 AC/APR 2010/AUD610/560

AUD 610/560
SUGGESTED SOLUTION
APR 2010

QUESTION 1

A. (i) Confidentiality

A member should respect the confidentiality of information acquired during the


course of his professional work and should not disclose any such information to a
third party without specific authority or unless there is a legal or professional right
or duty to disclose. A member must not use such information for his personal
advantage or that of a third party.
(2 marks)
(ii) Objectivity

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.

Candidates can then elaborate on threats to objectivity such as self interest


threat, self review threat, advocacy threat, familiarity or trust threat and
intimidation threat.
(2 marks)
B. (a) In the content of MIA By-Laws (On Professional Conducts and Ethics), the
obligation to disclose the above incident is as follows:

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.

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CONFIDENTIAL 2 AC/APR 2010/AUD610/560

(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.

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CONFIDENTIAL 3 AC/APR 2010/AUD610/560

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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CONFIDENTIAL 4 AC/APR 2010/AUD610/560

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:

 Manipulation, falsification or alteration of accounting records


 Misrepresentation or intentional omission from the Financial Statement or
events, or transactions or other significant information.

Error: Unintentional misstatement in the Financial Statement, including the


omission of amount or a disclosure. Examples include:

 A mistake in gathering or processing data from which financial statements are


prepared.
 An incorrect accounting estimate arising from oversight or misinterpretation of
fact.
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CONFIDENTIAL 5 AC/APR 2010/AUD610/560

(1 mark each for any acceptable explanation


and 1 mark each for the two examples given)
(4 marks)
(ii) Responsibility of auditor – plan audit & have sceptical mind when perform audit
so that any possibility of Fraud & Error can be detected.
(2 marks)
(iii) Good corporate governance practices include:
a. Review quarterly & year-end Financial Statement – focus on any changes in
accounting policies & practices.
b. Meetings attended by Finance Director, Head of Internal Audit,
representatives from external auditor and if required other board members
c. Audit Committee meets regularly to discuss any matter which they think is
necessary.
d. Audit Committee has the authority to investigate any matters within reference
term.
(1.5 marks for each acceptable answer + explanation given)
(6 marks)
B. i) Emphasis on the establishment of proper quality control procedures is to ensure:
a. To gain public confidence.
b. To maintain integrity and professionalism of the auditor.
c. To ensure that the auditor exercises due care in the performance of the audit
work.
d. To ensure that auditor follows the auditing standards
e. To minimise audit risk / risk of issuing an erroneous audit report.
f. To minimise legal action the auditor.
(Give 1 mark for any acceptable point = 4 marks)
ii) Reviewers should consider whether:

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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CONFIDENTIAL 6 AC/APR 2010/AUD610/560

(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)

(iii) Limitations of AR model:


a. The model assumes that its components are independent of one another
while they are likely to be dependent in the real world.
b. Since the auditor assesses IR and CR, such assessments may be higher or
lower than the actual IR and CR that exist for the client.
(2 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.

Other relevant points can be considered.


(1 mark each for the type of CAATs and
2 marks for benefits for 4 marks)

(ii) Factors to be considered:

a. Impracticality of manual tests where the computer programs often perform


functions of which no visible evidence is available.

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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CONFIDENTIAL 7 AC/APR 2010/AUD610/560

companies do not retain copies of computer files and programs for an


indefinite period, the auditor should plan the use of any CAAT n good time so
that these copies are retained for his use.

d. The auditor may also have to consider the extent of compliance or


substantive testing achieved both alternatives before deciding which method
to be used.

(1.5 marks for each acceptable explanation, 4 x 1 ½ marks = 6 marks)


(Total: 20 marks)

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.

(iii) Nature of the info to be supplied by the client.

(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.

(vi) Intended use & distribution of the info, once compiled.

(vii) Form of report to be rendered regarding the financial information compiled,


when the accountant’s name is to be associated therewith.
(4 marks)
B. (i) 2 types of Prospective Financial Information (PFI) :

a. Forecast – prepared on the basis of assumptions as to future events which


mgmt expects to take place & the actions mgmt expects to take as of the date
the info is prepared (best-estimate assumption).

b. Projection – prepared on the basis of hypothetical assumptions about future


events & management actions which are not necessarily expected to take
place, such as when some entities are in a start-up phase or are considering
a major change in the nature of operations; or a mixture of best-estimate &
hypothetical assumptions.
(2 x 1 mark = 2 marks)

(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)

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CONFIDENTIAL 8 AC/APR 2010/AUD610/560

(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

b. Auditor believes that 1 or more significant assumptions do not provide a


reasonable basis for the PFI prepared on the basis of best-estimate
assumptions or that 1 or more significant assumptions do not provide a
reasonable basis for the PFI given the hypothetical assumptions, or

c. The examination if affected by conditions that preclude application of 1 or


more procedures considered necessary in the circumstances.
(Any 2 explanation for 2 marks)

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.

a. Obtaining an understanding of the entity’s business & the industry in which it


operates.
b. Inquiries concerning the entity’s a/c principles & practices.
c. Inquiries concerning the entity’s procedures for recording, classifying &
summarizing transactions, accumulating info for disclosure in the FS &
preparing FS.
d. Inquiries concerning all material assertions in the FS.
e. Audit Procedures designed to identify relationships & individual items
considered unusual.
f. Any matters that required adjustment in prior periods.

Any other acceptable answer as listed in Appendix 2 of AI 2400 (p.938-946)


(4 marks)

(ii) Review of financial information is different from normal audit engagement


because auditor can only provide moderate assurance rather than reasonable
assurance.
(2 marks)

D. (i) The objective is for the professional accountant to evaluate or measure a


subject matter that is the responsibility of another party against identified suitable
criteria, and to express a conclusion that provides the intended user with a level
of assurance about the subject matter.
(2 marks)
(ii) Para 42 of ISAE 3000 elaborates that practitioner neither assumes that the
responsible party is dishonest nor assumes unquestioned honesty. Professional
scepticism is an attitude that includes a questioning mind and a critical
assessment of evidence. Without an attitude of professional scepticism, the
practitioner may not be alert to circumstances that lead to a suspicion, and may
draw inappropriate conclusions from the evidence obtained.
(2 marks)
(Total: 20 Marks)
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