Question

When producing an audit report, auditors may face different circumstances which may mean a True and Fair audit opinion is not appropriate.

Required:

Explain the potential effect on the final audit report of each of the following scenarios: (for outlining the effect on report and rationale. Three or four marks for each of the three scenarios to maximum of ten.)

1. Audit tests on purchases indicate a weakness in the internal control system, with a potential overstatement of cost of sales of HK$5 million. Total purchases amount to HK$100 million.
2. Just before the audit report is to be signed, a client which supplies fresh food to a major supermarket hears that it is being sued due to customer complaints of severe illness having bought and eaten the food supplied by the client. The client fears that this may lead to other lawsuits from many other people. The position has been fully explained in a note to be added to the notes to the accounts.
3. During testing of non-current assets, a substantial amount of equipment was found to be located at the home of one of the directors. Enquiries relating to the equipment indicate that the director makes personal use of it. The equipment is included in the non-current assets balance in the financial statements.

Auditors are required to comply with the fundamental ethical principles which can be put at risk in a variety of circumstances.

Required:

1. List five threats to independence and objectivity and for EACH threat identify ONE example of a situation that may cause the threat to occur. (for each threat identified and half mark for each example.)

During the planning of audits, auditors perform tests of controls. Below are examples of typical controls found in many businesses: (for valid tests of control tailored to the controls provided in the question.)

1. Bank reconciliation – document showing bank balance and accounting balance with adjustments for timing differences.
2. Authorisation of payments made to suppliers by signature of senior manager on payment instructions raised by payments clerk
3. Organisational chart showing directors and staff reporting lines.

Required:

Write down tests of controls which would give some assurance as to the effectiveness of the three controls noted above. You should write at least one procedure for each control.

Answer 1

Potential effect on the final audit report:

a. While checking the internal controls for weaknesses, if any material weaknesses are identified, the auditor must communicate them in writing to the management and to the audit committee. The written communication should be made prior to the issuance of the auditor's report. If the auditor concludes that the oversight of the company's audit committee is ineffective, the auditor must communicate the weaknesses to those charged with governance. If any deficiencies individually or in combinations are significant, they must be communicated in writing to the audit committee. This communication should be made in a timely manner and prior to the issuance of the auditor's report.

Unless the auditor becomes aware of any fraud due to this weakness in the internal controls, there is no effect on the final report of the auditor as the weakness in the internal controls are to be communicated before issuing the auditor's report.

b. In case of a contingent liability the auditor should estimate the likelihood that the event will occur. The auditors by using their professional judgment should determine if the amount is a material or not. The company must disclose material contingent liabilities in the notes to the financial statements. In given case the company has disclosed the position of its contingent liabilities in its notes to the financial statements. Thus the auditors report requires no modification, however the auditor's opinion must be drafted in such a way that it draws the attention of the users to the mentioned note and its possible impact.

c. Checking of the company's non-current assets is one of the major aspect while carrying on the audit. The auditor has to check for the existence of the non-current assets as reported in the financial statements of the company. The auditor further has to verify whether that these assets are properly valued and not being used for personal use by the company's authorities. In the given case a substantial amount of equipment was found to be located at the home of one of the directors and is made for personal use of the director. In such case, the auditor has to modify his report and mention the amount of the assets that are being used for personal purposes by the director. Since the amount of such assets is substantial, he should issue an adverse opinion as the amount involved is material and it can have pervasive effect as it is not being used for the company's objectives.

Note: As per HOMEWORKLIB POLICY, in case of multiple questions, only the first one needs to be answered.