ACFI 301 Jan 2013 Questions (1)

EXAMINER: Phil Ormrod/Claire MallanaphyDEPARTMENT: ULMS TEL. NO: x53505/x52482JANUARY EXAMINATIONS 2013Auditing Theory and PracticeTIME ALLOWED: Three HoursINSTRUCTIONS TO CANDIDATESAnswer Question 1 in Section A and any TWO questions from Section B. Three questions in all.SECTION AQuestion 1THIS QUESTION MUST BE ATTEMPTEDYour firm has recently been appointed as auditor of Prenton Ltd. The company owns a chain of 30 UK-based retail stor es, selling luxury Italian ladies‟ clothing and accessories. The company operates a central UK-based warehouse from which it supplies all 30 stores with inventory.The company purchases its inventory from a small number of major fashion wholesalers based in Italy. The majority of inventory items are the previous year‟s designs, which the wholesalers supply to Prenton at discounted prices. Prenton places all its orders centrally three times a year, coinciding with the Spring, Summer, and Winter seasons. All transactions are conducted in euro and payment is due in full on arrival of the goods in the UK.Most of the Penton‟s sales are conducted by cash, cheque, or credit card. In order to remain competitive with other major high street retailers, the company offers a returns policy to its customers which allows goods to be returned to the store within a reasonable time of purchase, for any reason, with a full refund offered. Goods returned under this policy are then sold on in bulk through the trade, sometimes at less than their original cost to Prenton.Clothes are transferred between stores when there is a shortage of some items of clothing at one store and a surplus at another. Initial audit testing has discovered that there are poor accounting records for these transfers.Prenton‟s managing director, aged 60, is also the company‟s main shareholder. He adopts a very hands-on approach to the business; he is involved in all major decisions and rarely delegates. He is known for his lavish lifestyle and in order to finance this he seeks each year to grow the business and improve upon the previous year‟s profitability.The company has recently acquired new offices adjacent to its central warehouse. The purchase was financed by significant bank borrowings under fixed-term loans, which require annual capital repayments.Required(a) Describe and distinguish the different elements of audit risk (i.e. inherent risk, control riskand detection risk) according to ISA 315 and ISA 330.(10 marks)(b) Identify, from the circumstances outlined above, the factors which indicate high audit risk inrespect of the audit of Prenton Ltd and, for each factor identified, explain why it contributes to high audit risk.(18 marks)(c) Explain, and critically appraise, the internal controls which Prenton Ltd should put in placeto ensure the complete recording of sales and safe custody of cash.(12 marks)Total: 40 marksSECTION BQuestion 2(a)Explain the term professional scepticism in the context of an audit and provide examples ofhow this concept may be applied.(15 marks)(b)You are a senior on the audit of Lapdog Ltd for the year ended 31 December 2012. You arecurrently reviewing the payroll section of the working papers, which have been prepared bya junior member of the audit team. The audit junior has commented as follows:…Several new employees have been added to the company‟s payroll during the year, withtotal payments of £125,000 being made to them. There does not appear to be anyauthorisation for these additions to the list of employees. When I questioned the payrollsupervisor who made the amendments, she said that no authorisation was neededbecause the new employees are only working for the company on a temporary paidinternship from university. However, when discussing staffing levels with management, itwas stated that no new employees have been taken on this year. Other than the tests ofcontrols, no other audit procedures have been performed.‟RequiredIn relation to the audit of Lapdog Ltd:(i)explain how professional scepticism may apply to the audit of payroll.(ii)recommend any further actions that should be taken by the audit team.(15 marks)Total: 30 marksQuestion 3“Common law in the UK and the Companies Act 2006 have made suc cessful litigation against negligent auditors, by both shareholders and third parties, increasingly difficult. These changes have been both in terms of, who can successfully litigate against auditors, and of the conduct which would constitute negligent beh aviour.”RequiredExamine the validity of this statement, clearly distinguishing contract law litigation from claims under the tort of negligence.Total: 30 marksQuestion 4(a) “The postulates approach to auditing has failed to develop any c oherent theory of auditing,or even any testable hypotheses about the nature and function of auditing in the modernbusiness environment. In essence, the various attempts at developing a postulatesapproach have done little more than set out some basic, and self-evident, propositionsabout auditing.”RequiredAssess the validity of the above statement. Refer to attempts made in the literature todevelop a postulates approach to auditing.(15 marks)(b)Critically appraise the extent to which agency theory can explain each of the following:(i)the willingness of companies to engage external auditors on a voluntary basis whenthere is no legal requirement to do so;(ii)the willingness of companies to engage quality-differentiated auditors when the cost of doing so is greater than other audit firms; andIn each case refer to relevant research, including empirical evidence.(15 marks)Total: 30 marksQuestion 5(a)Compare and contrast the nature and purposes of a statutory audit with an assuranceassignment. You should consider both reasonable assurance and limited assuranceassignments.(15 marks)(b)Examine the nature and usefulness of the concept of materiality according to ISA 320,Materiality.(15 marks)Total: 30 marksQuestion 6(a)The audit firm for which you work has been asked to provide the following additional services to existing audit clients:(1) Providing taxation services to the company and its directors.(2) Providing accountancy services, including preparing periodic management accounts andannual financial statements.(3) Providing management consultancy, including advice on new computer systems andsystems of internal control.(4) Preparing confidential reports to the company‟s bank and other lenders on the financialposition of the client. The conclusions of these reports are not made available to the audit client.RequiredFor each of the four situations listed above explain:(i) the threats to independence arising from the additional work; and(ii) the ways in which your audit firm could set up ethical safeguards to reduce the effects on independence arising from the provision of these additional services.(16 marks)(b)Explain and clearly distinguish the following threats to independences in the context of astatutory audit engagement: (i) self interest threat; and (ii) self review threat. Provideexplained examples of each threat to independence and the associated ethical concerns.(14 marks)Total: 30 marks。