Consider the following scenario:
You are the Independence Officer for your accounting firm (War Eagle, LLP). Individuals notify you when situations arise that they believe may impair the independence of the firm. You have received notifications from two individuals who have provided the following information:
John: He is an audit partner in the Birmingham office. His wife owns shares of stock in Tiger, Inc. which are not material to their net worth. The Tiger, Inc. audit is performed out of the Birmingham office, but John is not the engagement partner and does not serve as a quality review partner.
Jane: She is tax manager in the Auburn office. She owns stock in Shug, Inc. through a mutual fund. The amount invested in Shug, Inc. is material to her net worth. The Shug, Inc. audit is performed out of the Birmingham office, and Jane does not provide any services to them.
Assigned task:
Please draft a FORMAL email to John and Jane. In the emails you should notify the individuals whether there is an independence issue based on the information provided. The emails should be PROFESSIONAL including the tone, grammar, and spelling. You should also be very thorough in explaining why there is/is not an independence issue (discuss each aspect considered in the decision) as well as what could change that (i.e. how could the independence issue be resolved or what could change that would result in an independence issue when one does not exist).
You are an auditor on the AUS Limited (AUS) audit engagement for the financial year ending
30 September 2019. AUS is a large hotel company with more than 800 hotels in Australia and
Asia under a range of hotel brands. You are in the process of undertaking audit-planning
procedures for the AUS audit. You have noted a number of significant risks outlined below.
AUS’s revenue is made up of management fees earned from hotels managed by AUS under
long-term contracts with hotel owners, and from the rental of rooms and food and beverage
sales from hotels owned and leased by the company directly. In hotels owned and leased
directly by AUS, the company’s practice is to confirm hotel bookings by taking credit card
details and collecting payment for accommodation and incidentals at the end of a customer’s
stay. You have noted an increasing incidence of corporate clients prepaying for their
employees’ accommodation. These have been recorded as revenue when payment has been
received.
It has also come to your attention that there have been a growing number of disputes with hotel
owners in relation to the amount of management fees being charged. Management fees
included a base fee, a percentage of hotel revenue, and an incentive fee based on the hotel’s
profitability. Individual contracts negotiated with hotel owners include provisions for
percentage increases of the base fee either annually or biannually to take effect at specific dates.
Based on your initial review of the correspondence, it appears that AUS has been applying
percentage increases to the base fee charged to hotel owners prior to their effective date as
contained in the contracts with individual hotel owners.
AUS runs a hotel loyalty program which enables members of the program to earn points for
every dollar spent on an accommodation, food and beverages at AUS branded hotels. These
points may be redeemed at a later date for free accommodation or other benefits. AUS records
a loyalty program future redemption liability on the basis of the number of points expected to
be redeemed prior to their expiry multiplied by redemption cost per point. An announcement
was made on 30 May 2017 that points earned under the loyalty program would now expire in
two years rather than five years from the time they are earned. AUS’s management
subsequently reduced the amount provided in the loyalty program future redemption liability
by $80 million based on their estimate of the revised amount required to meet the liability given
the impact of the change.
AUS has embarked on a large-scale software development project in the current year to
internally develop improved guest reservation and hotel management systems. An amount of
$37 million for the year has been capitalised as software development during the year. Your
initial review has revealed that this amount includes repairs and maintenance of a range of
AUS’s hardware incurred during a year.
Required
(a) Considering the information provided, determine the four key account balances and
related assertions at risk. Briefly justify your answer. (8 Marks)
(b) Recommend one audit procedure in relation to each of the assertions identified above
(2 Marks)
(Total Marks 10)
(Maximum Word Limit 400)
Question 4 You are the audit senior on the audit of Harmony Pty Ltd, a large manufacturing company, for the year ended 30 June 2020. It is now 25 August, 2020 and you are reviewing the audit working papers prepared by the audit assistant, Ellen Richards, and notice the following matters:
a. Ellen attended the stocktake on 30 June and observed that the client followed the stocktake instructions. She selected numerous items for test inventory from the client’s inventory sheets and all were found to be correct. Cut-off details were noted and subsequently checked and found to be correctly treated. Ellen concluded that inventory was fairly stated.
b. Ellen selected 20 invoices to test the control that the sales clerk checks that the prices agree with the authorised price list. She found 3 instances where the sales clerk had not signed the “prices checked” box in the invoice. The sales manager explained that the sales clerk always checks the prices but sometimes forgets to sign the box. As the prices on all the invoices agreed with the authorised price list. Ellen concluded that the control was operating satisfactorily.
c. As part of her work on subsequent events, Ellen noted that there were a large number of returns in July of Product 75L. However, as this product was first sold in June and represented only 1% of sales for the year, Ellen concluded that the amount was immaterial and no further work was necessary.
d. Advertising expenses are material, although only 50% of last year’s balance. Ellen selected a large sample of entries and agreed them to supporting documents. No errors were found. Ellen concluded that advertising expenses was reasonable.
e. As part of the verification work on accounts payable, Ellen carried out a search for unrecorded liabilities. She tested a random sample of 20 payments made after 30 June, 20X7 and found 3 instances of cheques that related to services provided in June, which had not been accrued. However, as the total of the 3 cheques was immaterial, she concluded that no adjustment was required for unrecorded liabilities.
Required
For each of the five scenarios presented above, indicate whether you believe that sufficient appropriate audit evidence has been obtained to support the conclusions reached. Give reasons for your decision.
Topic: Corporate Fraud vs Auditors
Cases
- Carillion, United Kingdom, 2018
Construction giant Carillion collapsed under the weight of a £1.5 billion debt.
In May 2018, a UK parliamentary committee said its collapse was due to “recklessness, hubris and greed.” Accountants KPMG, which earned £1.5 million a year from the Carillion account, accused of rubberstamping figures that “misrepresented the reality of the business” as well as incurring a conflict of interest due to its work advising the pension scheme.
- Gupta, South Africa, 2018
Gupta Group, with business in mining, air travel, energy, technology and media, collapsed in February 2018,
KPMG faced very heavy criticism over work done for the Guptas, with whom it had worked for 15 years until stepping down in 2016, and was forced to issue a public apology as well as withdrawing findings in a report used as evidence in a police probe. Ex-KPMG auditor Jacques Wessels was subsequently charged with inappropriate conduct and tax evasion.
- General Electric (GE), United States, 2018
At the beginning of 2018, it was announced that the Securities and Exchange Commission (SEC) was investigating its “aggressive accounting” practices, a probe that widened throughout the course of the year when in October 2018 its $22 billion non-cash charge related to acquisitions came under scrutiny, with the Department of Justice also launching an investigation. In June it was removed from the Dow Jones Industrial Average, the only member left of the original 1896 index. John L Flannery stepped down as Chairman and CEO. GE’s market value fell by more than $200 billion over two years.
The relationship between the auditor KPMG and GE was described as “too cozy” – emblematic of the concerns about choosing accountants with whom a company has “chemistry”.
Its Nasdaq-listed shares slumped 83% since the company announced that its chief operating officer and some underlings may have fabricated billions of yuan in sales for 2019. Accounting firm Ernst & Young later said it discovered the fabrications when it audited the firm’s financial statements.
Lucking Coffee Inc.’s board is seeking the resignation of Chairman Charles Zhengyao Lu.
- Huawei, China, 2019
In May 2019, U.S. authorities charged Chinese telecom giant Huawei with nearly two dozen criminal charges and sought extradition of Huawei executive Meng Wanzhou from Canada.
The indictment alleges Huawei misled the U.S. and a global bank about its relationship with two subsidiaries, Huawei Device USA and Skycom Tech, to conduct business in Iran. In 2018, President Donald Trump reinstated all U.S. sanctions on Iran.
A second indictment alleges Huawei stole technology from phone company T-Mobile used to test smartphone durability plus obstructed justice and committed wire fraud.
Structure of Assessment
- Introduction
Explain (i) the purpose of external auditing; and (ii) the relationship between an auditor and an auditee.
- Discussion
You might need to research more facts for the cases listed above to support your answer.
Please identify each section by an appropriate heading.
- Discuss the concepts of common good and stewardship, and then analyse whether KPMG, in the above cases, has failed to promote common good and stewardship with respect to (i) companies’ shareholders; and (ii) communities at large, respectively.
Please adopt the following structure in your answer:
- Concepts of common good and stewardship
- KPMG’s promotion common good and stewardship to shareholders
- KPMG’s promotion common good and stewardship to communities at large
- Apply Australia’s Corporations Act 2001 to KPMG in the above cases.
Select two sections of the legislation from its index (e.g. Division 5: Section 324: Auditor rotation for listed companies; Division 6 Sections 325, 327, 328, 329, 331: Appointment, removal and fees of auditors for companies).
Discuss their intended purposes, and discuss whether they are effective in preventing auditors from behaving like KPMG had, viz. is the legislation effective and does it have a deterrent effect for its intended purpose?
Please adopt the following structure in your answer:
- First section: Intended purpose and deterrent effect
- Second section: Intended purpose and deterrent effect
- Apply Australia’s Auditing Standards, ASAs, to all the above cases.
Select two sections (e.g. ASA 230 Audit Documentation; ASA 240 The Auditor’s Responsibilities Relating to Fraud in an Audit of a Financial Report; ASA 500 Audit Evidence) of the Australian Auditing Standards (ASA) from its index.
Discuss the aspects of auditor’s auditing performance the sections intend to regulate, and whether they are adequate to uncover the fraud as committed in the above cases, respectively.
Please adopt the following structure in your answer:
- First ASA: Intended regulation of auditor’s performance and adequacy in uncovering the fraud in each of the above five cases
- Second ASA: Intended regulation of auditor’s performance and adequacy in uncovering the fraud in each of the above five cases
- “Beginning with the collapse of Carillion and through to the collapse of Thomas Cook, the Financial Reporting Council (FRC) UK was exposed as a toothless regulator with a “parasitical relationship” with the Big Four, facing its own dissolution…
Major issues include the fact that companies choose their own auditors, which means they go for those with a “cultural fit” or with whom they had “chemistry” rather than choosing a firm that was going to offer the toughest scrutiny. Another problem was limited choice. In UK, the Big Four firms conducting 97 per cent of the audits. There were worries that the focus of quality could be compromised by the fact that 75 per cent of the Big Four’s revenue came from other services including consulting.”
Discuss whether you would agree with the above opinion and concerns in a country of your choice, other than UK. You need to support your answer with appropriate facts and statistics, as exemplified by what is provided.
- Recommendations
Suggest a reform measure in (i) professional and ethical conduct of external auditors; (ii) legislation in regulating auditors; and (iii) auditing standards, respectively, in view of the above cases and concerns.