Auditing
Question 1
Part A:
The audit risk model has become the commonly used basis for audit planning. The following are independent situations that could have an effect on various components of the audit risk model.
For
each situation, identify the element(s) of the audit risk model (that
is, audit risk, inherent risk, control risk, and detection risk) that is
(are) most likely to be directly affected and the nature of the change
in risk levels (increase or decrease) relative to a typical audit.
Explain your reasoning in detail.
a. A company provides all customers with the option to return unused goods within two weeks of the purchase.
b. In
the current year, the company began performing credit checks for all
new customers. The customers’ credit ratings were used to determine
credit limits for the customers.
c. A
client’s sales team is primarily compensated on a commission basis.
Commissions are determined on a percentage-of-sales basis.
d. All cheques greater than a pre-determined limit require the signature of the controller and the chief financial officer.
e. In
order to raise capital, in the current year the owner-manager of a
business sold 20% of the common shares to a private-equity investor. The
owner will remain actively involved in the business. The private-equity
investor will not actively partake in the daily management of the
business.
f. An auditor tests a control and observes several compliance deviations.
g. In the past two prior-year audits, the auditor has identified several material overstatements in inventory.
Part B:
For each of the following independent situations, state whether the CGA has violated generally accepted auditing standards and/or the CGA-Canada Code of Ethical Principles and Rules of Conduct or Independence Standard and explain your reasoning in detail.
a. Emily,
CGA, owns a material amount of units in a mutual fund that owns stock
in Emily’s largest audit client. Reading the mutual fund’s most recent
financial report, Emily learned that the mutual fund significantly
increased its holdings in her client.
b. Martha,
CGA, has a practice with two departments. One department performs
assurance services and the other performs bookkeeping services. One of
her publicly accountable audit clients lost its controller and the
bookkeeping department provided controllership services for 30 days
while the company searched for a new controller. As this was an
emergency, it was necessary for Martha’s firm to provide the service
because it has an intimate knowledge of the client’s system.
c. In
an effort to expand his business, Mathew, CGA, places an advertisement
in the business section of the local newspaper listing specific services
he performs and his rate for performing each type of service, some of
which are available for a fixed fee and others for an hourly fee, which
was also stated in the advertisement.
d. Howard,
CGA, discovered, during the audit of his client Ignoble Enterprises
Inc., that the company had failed to include a significant amount of
income on last year’s corporate income tax return. Howard suggested to
the controller that he submit an amended return. When the controller
refused, Howard resigned from the engagement. Howard later received a
letter from the successor auditor asking if Howard was aware of any
circumstances that they should be aware of prior to accepting Ignoble as
a client. Howard replied by letter and informed the successor auditor
that Ignoble’s management failed to adjust income tax returns containing
significant material errors.
e. Emma,
CGA and auditor for Nestco (a public company), recommends that the
company improve its internal controls and accepts a 90-day engagement to
design and implement new controls, and to train company staff on them.
f. Harry,
a CGA student, is currently employed by a CGA firm in public practice.
He accepts a 15% discount on purchases from an audit client. Harry
believes that he has not violated the Rules of Conduct because he is not
yet a CGA member and the discount is at the same percentage that is
available to the client’s own staff members.
Question 2
The
purpose of substantive testing is to verify the assertions made by
management in the financial statements. Consider the following unrelated
audit tests, which a CGA performed for the audit of the financial
statements of a client with a fiscal year end of December 31, 2011.
Required
For each of the six audit procedures listed below, identify the primary management
assertion being tested and the account balance being verified, name the
specific audit procedure being used, and state the quality of the audit
evidence obtained (high, moderate, or low), explaining why the evidence
is the quality level you specify. Organize your answer with these
headings and provide detailed answers:
Management assertion
and account balance |
Audit procedure
|
Quality of audit
evidence |
a. Calculated the ratio for sales commission expense to sales as a test of sales commission. (2 marks)
b. Reviewed the accounts receivable balances with the credit manager to discuss collectability. (2 marks)
c. Obtained
a letter from the client’s lawyer stating that they are not aware of
any existing lawsuits filed against your client. (2 marks)
d. Examined a piece of equipment to make sure that the acquisition of the equipment took place and is operating. (2 marks)
e. Recalculated depreciation for each category of property, plant and equipment as at December 31, 2011. (2 marks)
f. Examined and counted Canadian government bond certificates held as investments as of December 31, 2011. (2 marks)
Question 3
The following are independent statements concerning certain auditing issues.
Required
Indicate whether you agree or disagree with each statement, and explain your reasoning in detail.
a. Each
of the following changes (considered independently and holding other
things constant) can be expected to decrease the level of detection risk
associated with the auditor’s substantive tests:
1. decreasing materiality
2. increasing inherent risk
3. decreasing audit risk
b. An
auditor was appointed to the audit of BID Inc. (BID) subsequent to
BID’s year-end date. BID is in the business of providing IT consulting
services and is also a computer equipment reseller. BID only orders
inventory from the manufacturer once a customer has placed an order.
This allows for BID to have low levels of inventory. As a result of
being appointed to the audit subsequent to year end, the auditor was
unable to attend the year-end inventory count and could not obtain
sufficient and appropriate audit evidence for the inventory balance. In
this circumstance the auditor should issue a qualified opinion due to a
scope limitation and the audit report should set out the nature of the
qualification in the auditor’s responsibility paragraphs.
c. When
the auditor’s preliminary assessment of control risk is that the
control risk is low to medium and the auditor plans to place some
reliance on the operating effectiveness of the controls to reduce the
amount of substantive testing, the sample size required in testing the
effectiveness of the controls should be larger since control risk is
lower.
d. Auditors
perform analytical procedures on the draft financial statements at the
planning stage of the audit looking for relationships that do not make
sense, as these may indicate problem areas where there may be material
misstatements.
e. In
audit and review engagements, an assessment of the CGA’s independence
from the entity is required, whereas in compilation engagements the
assessment is not required.
f. The
auditor will decide on the nature, extent, and timing of the audit
evidence to be obtained and evaluated. An auditor must obtain the best
available evidence with the consideration of cost.
g. The
auditor, in an audit using a combined approach, will rely on the
client’s internal controls. It is the auditor’s responsibility to
develop and implement effective controls.
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