Questions 1 12 cover Audit framework and regulation, the subject of Part A of the BPP Study Text for F8. 1 Audit regulation 18 mins (a) Explain how ISAs are developed by the International Auditing and Assurance Standards Board (IAASB). (5 marks) (b) Explain the role of the professional bodies in the regulation of auditors. (5 marks) (Total = 10 marks) 2 Corporate governance 18 mins (a) The UK's Combined Code on Corporate Governance is an established code of best practice and is mandatory only for UK listed companies. Required List the advantages and disadvantages of voluntary codes of corporate governance. (3 marks) (b) List four requirements for the board of directors as recommended by the UK's Combined Code. (4 marks) (c) Briefly explain the function of an audit committee. (3 marks) (Total = 10 marks) 3 Ethical issues 18 mins (a) List and briefly explain the main threats to independence and objectivity as identified in the ACCA's Code of ethics and conduct. (5 marks) (b) Briefly explain the fundamental principle of confidentiality and list the circumstances in which obligatory and voluntary disclosure of information may be applicable. (5 marks) (Total = 10 marks) 4 External audit (AIR 12/04) 36 mins The purpose of an external audit and its role are not well understood. You have been asked to write some material for inclusion in your firm's training materials dealing with these issues in the audit of large companies. Required (a) Draft an explanation dealing with the purpose of an external audit and its role in the audit of large companies, for inclusion in your firm's training materials. (10 marks) (b) The external audit process for the audit of large entities generally involves two or more recognisable stages. One stage involves understanding the business and risk assessment, determining the response to assessed risk, testing of controls and a limited amount of substantive procedures. This stage is sometimes known as the interim audit. Another stage involves further tests of controls and substantive procedures and audit finalisation procedures. This stage is sometimes known as the final audit. Describe and explain the main audit procedures and processes that take place during the interim and final audit of a large entity. (10 marks) (Total = 20 marks) 4 Questions 5 International Standards on Auditing (AIR 6/06) 36 mins International Standards on Auditing (ISAs) are produced by the International Auditing and Assurance Standards Board (IAASB), which is a technical committee of the International Federation of Accountants (IFAC). In recent years, there has been a trend for more countries to implement the ISAs rather than produce their own auditing standards. A school friend who you have not seen for a number of years is considering joining ACCA as a trainee accountant. However, she is concerned about the extent of regulations which auditors have to follow and does not understand why ISAs have to be used in your country. Required Write a letter to your friend explaining the regulatory framework which applies to auditors. Your letter should cover the following points: (a) The due process of the IAASB involved in producing an ISA. (4 marks) (b) The overall authority of ISAs and how they are applied in individual countries. (8 marks) (c) The extent to which an auditor must follow ISAs. (4 marks) (d) The extent to which ISAs apply to small entities. (4 marks) (Total = 20 marks) 6 Jumper (AIR 6/06) 36 mins You are the audit manager of Tela & Co, a medium sized firm of accountants. Your firm has just been asked for assistance from Jumper & Co, a firm of accountants in an adjacent country. This country has just implemented the internationally recognised codes on corporate governance and Jumper & Co has a number of clients where the codes are not being followed. One example of this, from SGCC, a listed company, is shown below. As your country already has appropriate corporate governance codes in place, Jumper & Co have asked for your advice regarding the changes necessary in SGCC to achieve appropriate compliance with corporate governance codes. Extract from financial statements regarding corporate governance Mr Sheppard is the Chief Executive Officer and board chairman of SGCC. He appoints and maintains a board of five executive and two non-executive directors. While the board sets performance targets for the senior managers in the company, no formal targets or review of board policies is carried out. Board salaries are therefore set and paid by Mr Sheppard based on his assessment of all the board members, including himself, and not their actual performance. Internal controls in the company are monitored by the senior accountant, although detailed review is assumed to be carried out by the external auditors; SGCC does not have an internal audit department. Annual financial statements are produced, providing detailed information on past performance. Required Write a memo to Jumper & Co which: (a) Explains why SGCC does not meet international codes of corporate governance (b) Explains why not meeting the international codes may cause a problem for SGCC, and (c) Recommends any changes necessary to implement those codes in the company. (20 marks) 7 ZX (AIR 6/05) 36 mins You are a recently qualified Chartered Certified Accountant in charge of the internal audit department of ZX, a rapidly expanding company. Turnover has increased by about 20% pa for the last five years, to the current level of $50 million. Net profits are also high, with an acceptable return being provided for the four shareholders. The internal audit department was established last year to assist the board of directors in their control of the company and to prepare for a possible listing on the stock exchange. The Managing Director is keen to follow the Questions 5 principles of good corporate governance with respect to internal audit. However, he is also aware that the other board members do not have complete knowledge of corporate governance or detailed knowledge of International Auditing Standards. Required Write a memo to the board of ZX that: (a) Explains how the internal audit department can assist the board of directors in fulfilling their obligations under the principles of good corporate governance. (10 marks) (b) Explains the advantages and disadvantages to ZX of an audit committee. (10 marks) (Total = 20 marks) 8 Conoy (6/09) 36 mins (a) Contrast the role of internal and external auditors. (8 marks) (b) Conoy Co designs and manufactures luxury motor vehicles. The company employs 2,500 staff and consistently makes a net profit of between 10% and 15% of sales. Conoy Co is not listed; its shares are held by 15 individuals, most of them from the same family. The maximum shareholding is 15% of the share capital. The executive directors are drawn mainly from the shareholders. There are no non-executive directors because the company legislation in Conoy Co's jurisdiction does not require any. The executive directors are very successful in running Conoy Co, partly from their training in production and management techniques, and partly from their 'hands-on' approach providing motivation to employees. The board are considering a significant expansion of the company. However, the company's bankers are concerned with the standard of financial reporting as the financial director (FD) has recently left Conoy Co. The board are delaying provision of additional financial information until a new FD is appointed. Conoy Co does have an internal audit department, although the chief internal auditor frequently comments that the board of Conoy Co do not understand his reports or provide sufficient support for his department or the internal control systems within Conoy Co. The board of Conoy Co concur with this view. Anders & Co, the external auditors have also expressed concern in this area and the fact that the internal audit department focuses work on control systems, not financial reporting. Anders & Co are appointed by and report to the board of Conoy Co. The board of Conoy Co are considering a proposal from the chief internal auditor to establish an audit committee. The committee would consist of one executive director, the chief internal auditor as well as three new appointees. One appointee would have a non-executive seat on the board of directors. Required Discuss the benefits to Conoy Co of forming an audit committee. (12 marks) (Total = 20 marks) 9 Ethical dilemma (AIR 6/02) 36 mins (a) You are a Chartered Certified Accountant and the newly appointed internal auditor of a company that is experiencing financial difficulties. As a condition for obtaining bank loans, the company has agreed to maintain specified liquidity ratios, asset to liability ratios, and gross profit margins. The draft financial statements for the period-end appear to show that the company has not succeeded in complying with some of these requirements. The profit figures are significantly affected by the calculation of bad debt and depreciation charges. There has been a suggestion to the effect that these could be changed, in order to meet the bank's conditions. There is a real danger that if the bank withdraws its funding, the company will become insolvent and will have to cease trading. The chief financial accountant has asked you to sign certain internal records that have been altered in order to show that the bank's conditions have been met. 6 Questions Required Explain the courses of action open to you in these circumstances. (10 marks) (b) You are the external auditor of the company in financial difficulties described in (a) above. You have noted that the calculations of the bad debt allowance and depreciation provisions have been altered in the current year and that as a result, the bank's requirements have been met. You also note that certain accounting policy changes have been made in relation to accounting for leases and that as a result, the profit targets expected by certain investment analysts have now been met. If the changes had not been made, the targets would not have been met. You have asked to speak to the internal auditor but you have been told that he is on long-term sick leave. The chief financial accountant is away on holiday and will not be back until shortly before the audit is due to be completed. Required In relation to the facts above, explain the: (i) Implications for the audit of the financial statements; (ii) Potential effect, if any, on the auditor's report on the financial statements; (iii) Implications for the continuing relationship between the audit firm and the client. (10 marks) (Total = 20 marks) 10 Confidentiality and independence (AIR 6/06) 36 mins (a) Explain the situations where an auditor may disclose confidential information about a client. (8 marks) (b) You are an audit manager in McKay & Co, a firm of Chartered Certified Accountants. You are preparing the engagement letter for the audit of Ancients, a public limited liability company, for the year ending 30 June 20X6. Ancients has grown rapidly over the past few years, and is now one of your firm's most important clients. Ancients has been an audit client for eight years and McKay & Co has provided audit, taxation and management consultancy advice during this time. The client has been satisfied with the services provided, although the taxation fee for the period to 31 December 20X5 remains unpaid. Audit personnel available for this year's audit are most of the staff from last year, including Mr Grace, an audit partner and Mr Jones, an audit senior. Mr Grace has been the audit partner since Ancients became an audit client. You are aware that Allyson Grace, the daughter of Mr Grace, has recently been appointed the financial director at Ancients. To celebrate her new appointment, Allyson has suggested taking all of the audit staff out to an expensive restaurant prior to the start of the audit work for this year. Required Identify and explain the risks to independence arising in carrying out your audit of Ancients for the year ending 30 June 20X6, and suggest ways of mitigating each of the risks you identify. (12 marks) (Total = 20 marks) 11 NorthCee (Pilot Paper) 36 mins You are the audit manager in the audit firm of Dark & Co. One of your audit clients is NorthCee Co, a company specialising in the manufacture and supply of sporting equipment. NorthCee have been an audit client for five years and you have been audit manager for the past three years while the audit partner has remained unchanged. You are now planning the audit for the year ending 31 December 20X7. Following an initial meeting with the directors of NorthCee, you have obtained the following information. (i) NorthCee is attempting to obtain a listing on a recognised stock exchange. The directors have established an audit committee, as required by corporate governance regulations, although no further action has been taken in this respect. Information on the listing is not yet public knowledge. Questions 7 (ii) You have been asked to continue to prepare the company's financial statements as in previous years. (iii) As the company's auditors, NorthCee would like you and the audit partner to attend an evening reception in a hotel, where NorthCee will present their listing arrangements to banks and existing major shareholders. (iv) NorthCee has indicated that the fee for taxation services rendered in the year to 31 December 20X5 will be paid as soon as the taxation authorities have agreed the company's taxation liability. You have been advising NorthCee regarding the legality of certain items as 'allowable' for taxation purposes and the taxation authority is disputing these items. Finally, you have just acquired about 5% of NorthCee's share capital as an inheritance on the death of a distant relative. Required (a) Identify, and explain the relevance of, any factors which may threaten the independence of Dark & Co's audit of NorthCee Co's financial statements for the year ending 31 December 20X7. Briefly explain how each threat should be managed. (10 marks) (b) Explain the actions that the board of directors of NorthCee Co must take in order to meet corporate governance requirements for the listing of NorthCee Co. (6 marks) (c) Explain why your audit firm will need to communicate with NorthCee Co's audit committee for this and future audits. (4 marks) (Total = 20 marks) 12 Stark (12/08) 36 mins You are a manager in the audit firm of Ali & Co; and this is your first time you have worked on one of the firm's established clients, Stark Co. The main activity of Stark Co is providing investment advice to individuals regarding saving for retirement, purchase of shares and securities and investing in tax efficient savings schemes. Stark is regulated by the relevant financial services authority. You have been asked to start the audit planning for Stark Co, by Mr Son, a partner in Ali & Co. Mr Son has been the engagement partner for Stark Co, for the previous nine years and so has excellent knowledge of the client. Mr Sonhas informed you that he would like his daughter Zoe to be part of the audit team this year; Zoe is currently studying for her first set of fundamentals papers for her ACCA qualification. Mr Son also informs you that Mr Far, the audit senior, received investment advice from Stark Co during the year and intends to do the same next year. In an initial meeting with the finance director of Stark Co, you learn that the audit team will not be entertained on Stark Co's yacht this year as this could appear to be an attempt to influence the opinion of the audit. Instead, he has arranged a balloon flight costing less than one-tenth of the expense of using the yacht and hopes this will be acceptable. The director also states that the fee for taxation services this year should be based on a percentage of tax saved and trusts that your firm will accept a fixed fee for representing Stark Co in a dispute regarding the amount of sales tax payable to the taxation authorities. Required (a) (i) Explain the ethical threats which may affect the auditor of Stark Co. (6 marks) (ii) For each ethical threat, discuss how the effect of the threat can be mitigated. (6 marks) (b) Discuss the benefits of Stark Co establishing an internal audit department. (8 marks) (Total = 20 marks)