AUDITING & ASSURANCE SERVICES I

UBAF2123/UKAF 2113 (MAY 2020)

Tutorial 2 –Lecture 2 –Objectives and Scope of Financial statements audits

Short essay question

Question 1
In planning the audit of a client’s non-current assets, an auditor derived the following
specific objectives from management’s financial statement assertions:
a. Non-current assets are not valued greater than recoverable amount in accordance
with an applicable accounting standard (valuation and allocation)
b. All non-current assets were on hand at year-end (existence)
c. Non-current assets include all purchases made during the financial year
(completeness)
d. Mortgages over non-current assets are properly disclosed in the financial
statements (classification and understandability) -account balances **need to
choose the sub-assertions, which is classification and understandability (under
presentation and disclosures) **more accurate- classification and
understandability, but presentation and disclosures also be the correct answer
e. All non-current assets on hand are owned. (right and obligation) **under
account balances
f. Obsolete non-current assets have been identified and revalued or written off as
appropriate (valuation and allocation) **referring to account balances- how to
revalue and dispose the NCA
g. Non-current assets have been properly classified in the balance sheet
(classification and understandability) **how to categorize the asset
**presentation and disclosures also the correct answer
h. All non-current assets under lease have been identified separately (classification
and understandability) **identify under leasing
i. Depreciation on non-current assets has been properly calculated (accuracy)
**depreciation is SOCI item—under assertions about classes of transactions
and events, so it is not valuation and allocation (NEED TO CHECK THE
NATURE OF THE ITEM!!!)
j. The non-current assets register has been totaled and the totals agree with the
figures in the general ledger. (valuation and allocation) **CHECK THE
NATURE OF THE ITEM—under account balances, nothing to do with SOCI
k. Total amount of sales have been checked with delivery order form and correctly
billed. (accuracy)
l. All sales transactions have been recorded in the sales account of December 2019.
(cut-off) **what this transaction happens is recorded in that period
m. Sales on goods are safely delivered to all existing customers within the stipulated
time. (occurrence) **occur and then complete

Required:
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For each specific audit objective, identify the management assertion from which it was
derived.

Question 2

For each of the following items, identify whether they are the responsibility of
management or of the auditor.

a) Distribute the annual report to shareholders (management)

b) Deliver the audit report to the entity (auditor)
c) Obtain and evaluate evidence concerning the financial statements (auditor)
d) Preparation and presentation of the financial report (management)
e) Designing internal control procedures (management)
f) Express an opinion on the financial statements (auditor)
g) Selecting appropriate accounting policies (management)
h) Verify financial information is presented in accordance with standards (auditor)

Scenario questions
Question 1
Wong & Associate accepted an engagement to audit the financial statements of HITEC
Sdn Bhd. The management indicated that there is a possibility of misstatements and
misappropriation of assets during the discussion with Mr Cheng CK, the manager in-
charge of this audit.
Required:
a) Discuss the responsibilities of Wong & Associate as an auditor in detecting and
preventing material misstatement due to fraud as per ISA 240. (5 marks)
The auditor is engaged to give an opinion as to give an opinion as to whether the
financial statements give a true and fair view. This means that the auditor is aiming
to detect material misstatements in the financial statements.
However, as per ISA 240, auditors do not have a duty to detect fraud.
Therefore, merely a duty to report whether the financial statements are fairly
presented, that is, they are not affected by material misstatements. Instead, this is a
duty of the directors to prevent fraud.
b) Briefly explain the responsibility of Wong & Associate in maintaining professional
skepticism when performing such audit towards HITEC Sdn. Bhd. (5 marks)
During the course of audit, the auditor is responsible for maintaining
professional skepticism throughout the audit. Professional skepticism refers to
an attitude that includes questioning mind and critical assessment of the audit
evidence. The auditor should not assume that management is dishonest nor
should be assumed unquestioned management honesty. Unless the auditor has
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reason to believe the contrary, the auditor may accept records and documents as
genuine. If the conditions identified during the audit cause the auditor to believe
that a document may not be authentic or that terms in a document have been
modified but not disclosed to the auditor, the auditor shall investigate further.
Question 2

You are Audit Manager of Chan & partners audit firm. Recently you have assigned a new
audit assistant to perform a fraud risk assessment in one of your clients. The said audit
staff is not familiar with the procedures and seek for your assistance as part of coaching
new auditor in charge for further actions.

Required:
Briefly describe to him the procedures for fraud risk assessment and also how auditor
would respond to the fraud risk assessed (20 marks)

Fraud risk assessment process

1) Communication among audit team
2) Inquiries of management and others
3) Identify Fraud Risk factors
4) Analytical procedures
5) Other Information

Note: For each above process, Refer slide 16-29 for further discussion.
(10 marks)

Auditor responses
3 level:
I. Overall responses
1) Increase professional skepticism
2) Assign and supervise personnel taking account of the knowledge, skill and
ability of the individuals to be given significant engagement responsibilities and
the auditor’s assessment of the risks of material misstatement due to fraud for the
engagement
3) Evaluate whether the selection and application of accounting policies by the
entity, particularly those related to subjective measurements and complex
transactions, may be indicative of fraudulent financial reporting resulting from
management’s effort to manage earnings
4) Incorporate an element of unpredictability in the selection of nature, timing and
extent of audit procedures
(3 marks)

II. Assertion level responses

The auditor’s responses to address the assessed risks of material misstatement due
to fraud at the assertion level may include changing the nature, timing and extent
of audit procedures in the following ways:
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1) The nature of audit procedures to be performed may need to be changed to

obtain audit evidence that is more reliable and relevant.
2) The timing of substantive procedure may need to be modified. The auditor may
conclude that performing substantive testing at or near the period end better
addresses an assessed risk of material misstatement due to fraud.
3) The extent of the procedures applied reflects the assessment of the risks of
material misstatement due to fraud. For example, increasing sample sizes or
performing analytical procedures at a more detailed level may be appropriate.
(3 marks)

III. Respond to the risk of management override of controls

Management is in a unique position to perpetrate fraud because of management’s
ability to manipulate accounting records and prepare fraudulent financial
statements by overriding controls that otherwise appear to be operating
effectively. The following step should be carried out
1) Test the appropriateness of journal entries recorded in the general ledger and
other adjustments made in the preparation of the financial statements
2) Review accounting estimates for biases and evaluate whether the circumstances
producing the bias, if any, represent a risk of material misstatement due to fraud.
In performing this review, auditor should evaluate whether the judgements and
decisions made by management in making the accounting estimates included in
the financial statements, even if they are individually reasonable, indicate a
possible bias on the part of the entity’s management that may represent a risk of
material misstatement due to fraud.
(4 marks)

Question 3

The following are the various potential frauds in the sales and collection cycle:
1. The company engaged in channel stuffing by shipping goods to customers that
had not been ordered. a. Fraudulent Financial Reporting. b. N/A. c. Confirm
receivables, including the existence of any special terms with customers.
2. The allowance for doubtful accounts was understated because the company
altered the aging of accounts receivable to reduce the number of days outstanding
for delinquent receivables. a. Fraudulent Financial Reporting b. N/A. c. Test the
accuracy of the aging by recalculating the number of days outstanding for a
sample of account receivables.
3. A cashier stole cash receipts that had been recorded in the cash register. a.
Misappropriation of Assets. b. Reconcile cash to amount recorded in the cash
register. c. N/A.
4. The company recorded “bill-and-hold sales” at year-end. Although the invoices
were recorded as sales before year-end, the goods were stored in the warehouse
and shipped after year-end. **sales not yet completed a. Fraudulent Financial
Reporting b. N/A. c. Confirm receivables, including the existence of any special
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terms with customers. Examine sales returns after year-end to see if they relate to
sales recorded before year-end.
5. The company did not record credit memos for return received in the last month of
the year. The goods received were counted as part of the company’s year-end
physical inventory procedures. a. Fraudulent Financial Reporting b. N/A. c.
Confirm accounts receivable at year end, including any special sales terms.
Inquire about the existence of goods held for customers during inventory
observation.
6. The accounts receivable clerk stole checks received in the mail and deposited
them in an account that he controlled. He issued credit memos to the customers in
the amount of the diverted cash receipts. a. Misappropriation of Assets. b. Credit
memos are approved by an appropriate person independent of accounting for sales
and cash receipts. c. N/A.

Required:
a) Indicate whether the fraud involves misappropriation of assets or fraudulent
financial reporting.
b) For those frauds that involve misappropriation of assets, state a control that would
be effective in preventing or detecting the misappropriation.
c) For those frauds that involve fraudulent financial reporting, state an audit
procedure that would be effective in detecting fraud.

Question 4
It is important that an auditor’s independence is beyond question and that he should
behave with integrity and objectivity in all professional and business situations. The
following are a series of scenarios which were given to auditors at a recent update
seminar on professional ethics.

The following scenarios were presented for discussion:

1. On 20 June 2019, the audit engagement partner of Wong & Co. visited the offices
of Holiday Club, a limited liability company, to plan the final audit procedures for
the year ending 31 August 2019. A week later, each of the five partners of Wong
& Co received an unsolicited letter from the Managing Director of Holiday Club
offering one year’s free membership at one of the company’s golf and country
clubs with effect from 1st September 2019. Individual annual membership
normally costs $3,000 and the offer was not made to anyone else.

2. Heng & Co, a long-established firm, audits the financial statements of two private
companies owned by Adam Smith, an entrepreneur with a very dominant
personality. The annual total fee income of Heng & Co is $830,000 and the
combined audit fees attributable to the two companies is $72,000. Adam Smith
has recently approached Heng & Co with a view of appointing them as auditors to
a third limited liability company under his control. The projected annual auditing
fee for the third-party company is $80,000.
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REQUIRED:

(i) Explain why it is so important for an auditor to be seen as independent.

(2 marks)
Need to the seen as independent because it is important the users of the financial
statements have confidence in their independence. Independence in appearance is
the result of others interpretation.
(ii) For each of the above scenario:
(a) Comment on any concerns you may have regarding the threat to auditor
independence and objectivity.
(3 marks)

(b) Recommend appropriate action to be taken by the audit firm to safeguard

against the threats you identified. (3 marks)

(a) & (b)

Scenario 1
The value of $3,000 of individual gold membership would not be
considered to be modest and the threat to the audit objectivity of
Wong & Co. is compounded by the fact that the total value of the offer to
the firm is $15,000 (5 auditors * $3,000). On this basis, the objectivity
could be, or perceived to be threatened, it is strongly recommended
that the partners politely decline the offer.

In addition, the move of the managing director in making the offer

should be concern. Given the total value of the offer, the timing of the
offer and the fact it was made solely to the partners would give rise to
the possibility that in return to the free membership, the company
may have unreasonable expectations as to how the audit firm may
respond when coming across contentious issues in the company’s financial
statements, for example, the adoption of unacceptable accounting policies.

Scenario 2
Public perception of a firm’s objectivity is likely to be in jeopardy where
the fees for audit and other recurring work paid by one client or
group of connected clients exceed 15% of the gross practice income.
The figure stated of 15% is an indicative figure only, relating to non-public
interest and non-listed companies.

Currently fees receivable from the two companies owned by Adam Smith,
represents 8.7% (72,000/830,000) of Heng & Co’s gross practice income.
This would not appear to represent a threat to the perceived
objectivity of the firm with regard to the existing audits. However,
acceptance of the third audit appointment would mean that 18.3%
(80,000+72,000/830,000) of the firm’s objectivity with regard to all
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three audit assignments, and in the circumstances, it may be prudent

for Heng & Co to politely decline for the further audit appointment.

Commercial consideration may encourage Heng & Co to accept the

third appointment, notwithstanding any doubts as to their perceived
objectivity. However, Adam Smith is an entrepreneur with a very
dominant personality. He could use the threat of the loss of all three audit
assignments to put undue pressure on the firm. For e.g. they may request
the firm to take unusually optimistic view as to the recoverability of
unpaid debts. The partners should pay particular attention to the possibility
of this threat before deciding whether to accept the further appointment.

If the firm does proceed with the additional appointment it is strongly

recommended that the partners should implement additional safeguards
to maintain objectivity.