Question 1 solution

Date

The Board of Directors

Local Hospital

To whom it may concern:

I am writing this letter on behalf of the CGA firm of Blogger and Blather at your request to explain what a
value-for-money audit entails and how a value-for-money audit would assist you and the management of the
hospital in the conduct of the hospital’s activities.

Definition

A value-for-money audit would examine the efficiency and effectiveness of the hospital’s operations. It would
attempt to establish whether or not the resources committed to the hospital by the community are being used
in the best way possible.

Application of value-for-money to the hospital operations

The audit would examine all the operations of the hospital over several (usually five) years. The audit team
uses experts from the particular area being audited under the direction of staff from our audit firm. For
example, when auditing the kitchen and meal-planning area, we would use a dietician, a nutritionist, and a
cooking expert. The combined team would be able to provide a comprehensive assessment of the efficiency
and effectiveness of the food preparation service.

Purpose of the audit

The purpose of our audit is not to cast blame, but rather to make suggestions about how things might be done
better in the future. Our reports will have a future orientation, and we will be making positive
recommendations as to improvements that would lead to greater efficiency and effectiveness. Each report will
be thoroughly discussed with management of the area being audited before being presented to you, so we can
ensure that the auditee supports our suggestions.

What the audit can do for the hospital

We realize that resources for all hospitals are strained at this time and that you, like all boards, would like to
manage your resources with due regard for efficiency and effectiveness. We believe that the hospital is well run
at present but think that improvements are possible. Our team has the expertise and independence to look at
the hospital’s operations with a view to helping you run the hospital better by making the most of the limited
resources at your disposal.

Please contact us if you have any questions.

Yours truly,

Blogger and Blather, CGAs

Question 2 solution

a. Determine the impact of the flood on the client. Are there other suppliers who can fill the gap? If
the effect is isolated, the auditor may examine just the evidence related to the subsequent event
and update the date of the report. Is there a going-concern issue for the client as a result of
this? If the effect is pervasive, the auditor will have to update all evidence relating to the
statements. However, if there is another satisfactory assured source of supply, there will be no
need for either disclosure of the event or any modification to the auditor’s report.
 The report hasn’t been approved yet, so if the effect is isolated, the auditor updates the field
work and changes the date of the report. If the effect is pervasive, the auditor uses a new date
corresponding to the date to which the audit work has been updated and subsequently approved
by the board.

b. Nothing needs to be done regarding the fire because the event occurred after the report was
issued and doesn’t misstate the statements as of the report date. However, you may wish to
make a note to the file for next year (assuming there is a next year).

c. With respect to the bank confirmation, because you discovered a material error in the financial
statements after the audit report was issued, you should discuss the matter as soon as possible
with management and likely the board. You would also want the statements recalled and new
statements issued. The new auditor’s report should either be double-dated or dated with the new
date. In the paragraph following the opinion, the new report should refer to the old report and
state that the old report has been withdrawn.

In any case, the audit firm would want to understand why this happened and why it was not
picked up in the file review. Moreover, the firm should probably absorb the cost of the extra
work.

If the situation were different, and if the misstatement were caused by client error or fraud, the
process would be the same. Discuss with the client why it occurred. If there is employee fraud,
management and those charged with governance must be advised. If the owner of the company
is committing the fraud, consider why the engagement was accepted. In this situation, the audit
firm usually bills the client for the extra work.

Question 3 solution

a. Circumstances in which a second opinion can be sought include the following:

when there is a dispute between the auditor (incumbent accountant) and

management over a particular accounting treatment or auditing or review standards
when advice or feedback is sought on a specific transaction on which the incumbent
accountant has already provided feedback

b. In addition to an engagement letter, the second accountant needs the following information:

access to the incumbent accountant

a written statement of the nature of the circumstances giving rise to the issue
about which the second opinion is sought

Question 5 solution

a. Opening balances refer to the amounts on a client’s balance sheet at the beginning of a fiscal
year. The accuracy of opening balances affects the accuracy of the income statement and
statement of cash flows in the current fiscal year. For example, if opening assets are overstated
but ending assets are correct, net income will be understated. Conversely, if opening liabilities are
overstated but ending liabilities are correct, net income will be overstated.

Since in this case another CGA firm audited the opening balances, the best way to determine
their accuracy would be through a review of the predecessor auditor’s working papers after
obtaining the client’s permission to contact the predecessor. In performing such a review, the
successor auditor (you) would evaluate the quality of the predecessor’s work and determine if
sufficient appropriate evidence regarding opening balances was obtained. If you believe that more
work is needed, the tests performed would be similar to the tests performed on the ending
balance sheet accounts.

You must reassess the impact of the evidence obtained and related to accounting policies
 regarding opening balances on the current year’s auditor’s report.

b. If you were unable to obtain sufficient appropriate evidence with respect to the material opening
balances, you would have to qualify your opinion on the current year’s financial statements
because of a scope restriction, or issue a denial of opinion. However, if you had sufficient
appropriate evidence with respect to the ending balance sheet accounts, you could give an
unqualified opinion on the ending balance sheet while qualifying (scope) or denying an opinion on
the income statement, statement of cash flows, and statement of changes in retained earnings
for the current fiscal year.

c. According to CAS 710.13, if the financial statements of the prior period were audited by a
predecessor auditor and the auditor is not prohibited by law or regulation from referring to the
predecessor auditor’s report on the corresponding figures and decides to do so, the auditor shall
state in an Other Matter paragraph in the auditor’s report:

a. That the financial statements of the prior period were audited by the predecessor
auditor;
b. The type of opinion expressed by the predecessor auditor and, if the opinion was
modified, the reasons therefore; and
c. The date of that report.

Question 3 solution

Here are the applicable steps from the nine-step approach to case analysis.

Identify problems and issues

College Corners Long-Term Care Facility is a not-for-profit facility that has sizeable net income for the current
fiscal year. Jennifer, the CFO, is concerned these profits will not be well received by the local community. She
therefore wants to change the accounting policies and restrict donations to hide the surplus. She wants to be
able to spend the surplus as she wants without returning it or obtaining authorization on how to spend it. Fred,
the audit manager, says it is okay to change polices to be more conservative by increasing expenses. Ann, the
audit senior, is concerned about the long-term care facility’s attempts to reduce net income.

Generate alternatives

Ann’s alternatives are to (1) accept Dave’s (the controller's) explanation and Fred’s (her manager’s) judgment,
(2) challenge Fred’s justification and push for consistent, fair reporting, bringing the concerns to the attention
of the engagement partner, and/or (3) reject Dave’s explanation and threaten to go to the College Corners’
board.

Select the decision criteria

The chosen alternative must consider the needs and interests of all stakeholders and be ethically sound (in
compliance with CGA-Canada’s Code of Ethical Principles and Rules of Conduct).

Analyze and evaluate the alternatives

In assessing these alternatives, Ann should consider the motivations and consequences of her decisions for the
following stakeholders:

Jennifer, the CFO, is concerned that the government will reduce reimbursements if long-term care
facilities show sizeable profits. She is also concerned that the local community will expect more or
better services or reduced charges.

Dave, the controller, is implementing the policy changes suggested by Jennifer in order to meet
management’s target of 0.5% of patient revenue. He seems preoccupied with meeting this target
at the expense of consistent and fair presentation.
 Fred, the audit manager, thinks any change that is conservative is safe to adopt and that
opposing the CFO may result in losing the client.

The government relies on the statements to represent fairly the cost of operations in order to
apply the cost formula and make future funding and reimbursement decisions.

The local community, which pays taxes to the government, wants the long-term care facility to
provide better services or reduce its charges if the long-term care facility is being reimbursed in
excess of its costs.

Ann should also determine the possible consequences of each alternative:

1. Accept Dave and Fred’s decision.

Allowing College Corners to hide its surplus ensures the audit firm retains the client, and Fred will
not see Ann as a troublemaker. However, Ann will have compromised her values. Hiding the
 change in accounting policies may come to light at a later stage, and she and the
firm’s work may be questioned. College Corners will continue to get funding, and the
government and the public will be unaware that they are overpaying the long-term
care facility.

2. Challenge Fred’s decision and push for consistent and fair reporting, bringing her
concerns to the attention of the engagement partner.

Ann may not be able to convince Fred that conservatism isn’t an excuse for hiding
profits. Fred may overrule her objections and view her as uncooperative and a
troublemaker. If Fred continues to support College Corners’ attempt to hide profits,
Ann may have to discuss the situation with him and possibly resign from the
engagement or from the firm.

Alternatively, Ann may be able to convince Fred to rethink his position and opt for fair
presentation, thereby winning his respect. College Corners may change its mind or it
may look for a new auditor. Either way, the firm will have done the right thing.
Whatever the result of challenging the manager’s decision, Ann will have maintained her
integrity.

3. Reject Fred’s decision and threaten to notify the board or firm partner.

Ann’s threat to notify the board may cause Dave to back down and agree with her.
College Corners’ profits will be disclosed and the public will be well served. However,
Fred may view this threat by Ann as a challenge to his authority.

If Ann has to follow through with her threat and go to the board, the board will likely
be concerned about any media coverage and accept her recommendations to
disclose the profits. College Corners’ administration may then take steps to change
audit firms, and Ann could be in trouble with the audit firm. It may be wiser for Ann
to discuss the issue with the audit partner before taking such drastic action. (Many
would not consider this option to be a practical alternative as it is one that might
breach both confidentiality and her position in the audit firm.)

Make a recommendation or decision

A change in amortization policy that results in increasing expenses by $1 million is a significant

decision. All the changes Dave is proposing will probably cause material misstatements that will
affect the decisions made by statement users. Permitting these changes to remain hidd en is
unethical. Unless there are new circumstances warranting a change to the half-year rule, GAAP
requires that the change be disclosed and applied retroactively with restatement of prior periods if
possible. Ann should document all the adjustments made and present her case to her manager. If
Fred does not accept Ann’s concerns, she should explain the situation and her reservations to the
audit partner.