Documente Academic
Documente Profesional
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ii
Contents
Page
Question Index
iv
Introduction
vi
Exam techniques
viii
Action verbs
Questions
Answers
63
Contents
iii
Question index
Title
Marks
allocated
Time
allocated
(Minutes)
Page
Question
Answer
Section 1
1
Mahmood
25
45
63
David
25
45
66
Anne
25
45
70
Poodle
25
45
74
Lychee
25
45
77
Axis & Co
25
45
79
Willow
25
45
10
81
Colombo
25
45
12
84
Banana
25
45
16
87
10 Retriever
25
45
17
91
11 Dragon Group
25
45
19
96
12 Lapwing
25
45
20
100
13 Baltimore
25
45
22
103
14 Apricot
25
45
25
109
15 Beech
25
45
26
112
16 Seatown
25
45
28
115
17 WWW
25
45
29
117
18 VV
25
45
31
120
Section 2
iv
Daily Newspapers
50
90
33
124
Farama 1
50
90
40
131
Farama 2
50
90
47
138
Aybe 1
50
90
50
145
Aybe 2
50
90
57
149
Introduction
Welcome to this first edition Practice & Revision Kit for the Institute of Chartered
Accountants of Sri Lanka professional examinations for curriculum 2015.
One of the key criteria for achieving exam success is question practice. There is
generally a direct correlation between candidates who revise all topics and practise
exam questions and those who are successful in their real exams. This Practice &
Revision Kit gives you ample opportunity for such practice in the run up to your
exams.
The Practice & Revision Kit is structured to follow the modules of the Study Text, and
comprises banks of non-complex mini scenario and simple functional scenario
questions as appropriate. Suggested solutions to all questions are supplied.
We welcome your feedback. If you have any comments about this Practice &
Revision Kit, or would like to suggest areas for improvement, please email
learningdevelopment@casrilanka.org.
Good luck in your exams!
Introduction
Revise the subject matter a module at a time and then attempt the questions
relating to that module; or
Revise all the modules and then build an exam out of the questions in this
Practice & Revision Kit.
vi
If you did not reach the correct answer make sure that you work through the
explanation or workings provided, to see where you went wrong. If you think that
you do not understand the principle involved, go back to your own notes or your
study materials and work through and revise the point again, to ensure that you will
understand it if it occurs in the exam.
Our suggested solutions are comprehensive, but in some discursive questions it may
be that you have made points that are not included in the suggested solution that are
equally valid. In the real exams you should be given credit for such points.
vii
Exam techniques
Using the right techniques in the real exam can make all the difference between
success and failure.
Here are a few pointers:
1.
During the 20-minute reading time at the start, read through the questions and
decide in what order you are going to attempt the exam. You have to write
your answers in the order set out in the question and answer booklet, but you
can attempt the questions in any order that you like.
Some candidates like to attempt the easiest questions first, on the basis that will
enable them to gain the easiest available marks quickly, and build up their
confidence.
If you select a question on a topic area about which you feel confident, and do
that first, you will build up your confidence right at the start, which will help to
calm you if you are nervous and set the tone for the rest of the exam. You should
decide what approach is best for you.
viii
2.
Having established the order that you are going to do the exam, allocate the
time available to the questions and work out at what time you will need to
stop working on one question and move on to the next. When you reach the end
of the allocated time for the question that you are working on, STOP. It is much
easier to gain the straightforward marks for the next question than to spend a
long time working on the previous question in the hope of gaining one or two
final marks.
3.
Read the question. Read it carefully once, and then read it again to ensure that
you have picked everything up. Make sure that you understand what the
question wants you to do, rather than what you might like the question to be
asking you.
4.
Answer all parts of the question. Even if you cannot do all of the calculation
elements, you will still be able to gain marks in the discussion parts.
5.
Dont worry if you think that you have made a mistake in a computational part
of a question. You will not earn the mark for that particular part, but you will
still be able to gain credit for correct application in the later parts of the
question, even if you are using the wrong figure.
6.
When starting to read a question, especially a long case study, read the
requirement first. You will then find yourself considering the requirement as
you read the data in the scenario, helping you to focus on exactly what you have
to do.
7.
Plan your answer before you start to write your response, especially for longer
case studies. This will help you to focus on the requirements of the question and
to avoid irrelevance.
8.
Try to make sure that your answer relates to the specifics of the question
itself. If you are asked to consider the impact of the scenario on someone named
in the question, make sure that you do that, so your answer is as relevant as
possible.
9.
If you finish the exam with time to spare, use the rest of the time to review your
answers and to make sure that you answered every requirement of every
question.
Exam techniques
ix
Knowledge Process
Verb List
Verb Definitions
Tier 1 Remember
Define
Recall important
information
Draw
Identify
List
Relate
State
Tier 2 Comprehension
Calculate/Compute
Explain important
information
Discuss
Explain
Interpret
Recognise
Record
Summarise
Knowledge Process
Verb List
Verb Definitions
Tier 3 Application
Apply
Assess
Demonstrate
Graph
Prepare
Prioritise
Reconcile
Solve
Analyse
Compare
Contrast
Differentiate
Outline
Tier 4 Analysis
Draw relations among ideas
and to compare and
contrast/solve open-ended
problems
xi
Knowledge Process
Verb List
Verb Definitions
Tier 5 Evaluate
Advise
Convince
Criticise
Evaluate
Recommend
Resolve
Validate
Compile
Design
Develop
Propose
Tier 6 Synthesis
Solve unfamiliar problems
by combining different
aspects to form a unique or
novel solution
xii
Questions
CA Sri Lanka
Questions
Section 1
1 Mahmood
45 mins
CA Sri Lanka
(1)
Advise how Mahmood might act, in each case, if he were to adopt either
conventional or post-conventional ethical assumptions according to
Kohlbergs definitions of these terms. Your answer should include an
explanation of these two terms.
(8 marks)
(2)
(3)
Questions
Required
Advise how such a requirement may have helped to prevent the undisclosed
use of the inferior meat at Tzo Company.
(9 marks)
(LO 1.4.1, LO 1.4.2 and LO 1.1.1)
2 David
(Total = 25 marks)
45 mins
(ii)
A recent United Nations report ranked EPC's home country in the Top 10 of
its worst polluters, as measured by CO2 emissions per head of population.
This report has been seized upon by environmental groups who have called
for a month of action during the general election campaign. They wish to
highlight the environmental damage being caused by the government's
environmental policies and to highlight the need to switch to alternative
technologies such as wind power generation.
In the last few days small groups of protestors have broken through
perimeter fences at two of EPC's power stations and managed to delay
deliveries of coal by chaining themselves across railway tracks. There have
CA Sri Lanka
Questions
been some reports in the press of heavy handed treatment being meted out
by the security firm hired by EPC to deal with the protests. EPC's Managing
Director has dismissed these reports, saying the protestors' solutions are
impractical, they have no rights of access, and that EPC is entitled to take
whatever action is required against the protestors to protect its property
and maintain electricity supplies.
Required
(1)
(2)
Evaluate the factors that EPC's board should consider when dealing with the
current protests by environmental groups using Tucker's model for
decision-making,
(10 marks)
3 Anne
(Total = 25 marks)
45 mins
Questions
and the audit firm were under time pressure to conclude business and get the
audit signed off.
When Anne told Zachary what Frank had said, Zachary agreed not to get the audit
signed off without Anne's support, but warned her that she should be very certain
that the irregularity was worth delaying the signoff for. It was therefore now
Anne's decision whether to extend the audit or have it signed off by the end of
Friday afternoon.
Required
(1)
Anne is experiencing some tension due to the conflict between her duties and
responsibilities as an employee of Fillmore Pierce and as a qualified professional
accountant.
Required
(2)
(i)
(ii)
Evaluate the ethical tensions between these roles that Anne is now
experiencing.
(4 marks)
(3)
(4)
Evaluate Annes ethical dilemma from Kolhbergs conventional and preconventional moral development perspectives.
(4 marks)
4 Poodle
(Total = 25 marks)
45 mins
You are the manager responsible for the audit of the Poodle Group (the Group)
and you are completing the audit of the consolidated financial statements for the
year ended 31 March 20X3. The draft consolidated financial statements recognise
revenue of $18 million (20X2 $17 million), profit before tax of $2 million (20X2
$3 million) and total assets of $58 million (20X2 $59 million). Your firm audits all
of the components of the Group, apart from an overseas subsidiary, Toy Co, which
is audited by a small local firm of accountants and auditors.
The audit senior has left a file note for your attention. You are aware that the
Group's annual report and financial statements are due to be released next week,
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Questions
and the Group is very reluctant to make any adjustments in respect of the matters
described.
(1)
Toy Co
The component auditors of Toy Co, the overseas subsidiary, have been
instructed to provide the Group audit team with details of a court case which
is ongoing. An ex-employee is suing Toy Co for unfair dismissal and has
claimed $500,000 damages against the company. To comply with local
legislation, Toy Co's individual financial statements are prepared using a
local financial reporting framework. Under that local financial reporting
framework, a provision is only recognised if a cash outflow is virtually
certain to arise. The component auditors obtained verbal confirmation from
Toy Co's legal advisors that the damages are probable, but not virtually
certain to be paid, and no provision has been recognised in either the
individual or consolidated financial statements. No other audit evidence has
been obtained by the component auditors.
(9 marks)
(2)
Trade receivables
On 1 June 20X3, a notice was received from administrators dealing with the
winding up of Terrier Co, following its insolvency. The notice stated that the
company should be in a position to pay approximately 10% of the amounts
owed to its trade payables. Poodle Co, the parent company of the Group,
includes a balance of $1.6 million owed by Terrier Co in its trade receivables.
(8 marks)
(3)
Chairman's statement
The draft chairman's statement, to be included in the Group's annual report,
was received yesterday. The chairman comments on the performance of the
Group, stating that he is pleased that revenue has increased by 20% in the
year.
(8 marks)
Required
In respect of each of the matters described:
(i)
Evaluate the implications for the completion of the Group audit, explaining
any adjustments that may be necessary to the consolidated financial
statements, and recommending any further procedures necessary; and
(ii)
Advise the audit senior on the impact on the Group audit report if these
adjustments are not made.
Note. The split of the mark allocation is shown above against each of the parts.
(LO 4.3.1, 4.4.1, 4.4.2, 4.7.1, 4.8.1)
CA Sri Lanka
(Total = 25 marks)
Questions
5 Lychee
(1)
45 mins
You are the manager responsible for the audit of Lychee Co, a manufacturing
company with a year ended 30 September 20X9. The audit work has been
completed and reviewed and you are due to issue the auditor's report in
three days. The draft audit opinion is unmodified. The financial statements
show revenue for the year ended 30 September 20X9 of $15 million, net
profit of $3 million, and total assets at the yearend are $80 million.
The finance director of Lychee Co telephoned you this morning to tell you
about the announcement yesterday, of a significant restructuring of Lychee
Co, which will take place over the next six months. The restructuring will
involve the closure of a factory, and its relocation to another part of the
country. There will be some redundancies and the estimated cost of closure
is $250,000. The financial statements have not been amended in respect of
this matter.
Required
In respect of the announcement of the restructuring:
(2)
(i)
(ii)
The finance director is aware that there is guidance for auditors relating to
audit reports in SLAuS 706 Emphasis of Matter Paragraphs and Other Matter
Paragraphs in the Independent Auditor's Report. The finance director has
asked for your assistance in this matter.
Required
(i)
(ii)
(Total = 25 marks)
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Questions
6 Axis & Co
45 mins
You are the manager responsible for four audit clients of Axis & Co, a firm of
Chartered Certified Accountants. The year end in each case is 30 June 20X8.
You are currently reviewing the audit working paper files and the audit seniors'
recommendations for the auditor's reports. Details are as follows.
(1)
Lorenze Co has changed its accounting policy for goodwill during the year
from amortisation over its estimated useful life to annual impairment testing.
No disclosure of this change has been given in the financial statements. The
carrying amount of goodwill in the statement of financial position as at
30 June 20X8 is the same as at 30 June 20X7 as management's impairment
test shows that it is not impaired.
The audit senior has concluded that a qualification is not required but
suggests that attention can be drawn to the change by way of an emphasis of
matter paragraph.
(6 marks)
(2)
(3)
Required
For each situation, recommend the suitability or otherwise of the audit senior's
proposals for the auditor's reports. Where you disagree, recommend what audit
modification (if any) should be given instead.
Note. The mark allocation is shown against each of the three issues.
(4)
CA Sri Lanka
You are responsible for answering technical queries from other managers
and partners of your firm. An audit partner left the following note on your
desk this morning.
Questions
(i)
'I am about to draft the audit report for my client, Sycamore Co. I am
going on holiday tomorrow and want to have the audit report signed
and dated before I leave. The only thing outstanding is the written
representation from management I have verbally confirmed the
contents with the finance director who agreed to send the
representations to the audit manager within the next few days. I
presume this is acceptable?'
(5 marks)
(ii)
'We are auditing Sycamore Co for the first time. The prior period
financial statements were audited by another firm. We are aware that
the auditor's report on the prior period was qualified due to a material
misstatement of trade receivables. We have obtained sufficient
appropriate evidence that the matter giving rise to the misstatement
has been resolved and I am happy to issue an unmodified opinion. But
should I refer to the prior year modification in this year's auditor's
report?'
(5 marks)
Required
Advise on the audit partner's comments.
Note. The split of the mark allocation is shown within the question.
(LO 4.5.1, 4.7.1, 4.4.1, 4.4.2, 4.3.1, 4.3.2, 4.6.1)
7 Willow
(Total = 25 marks)
45 mins
10
CA Sri Lanka
Questions
Laurel, has not written off this inventory as she argues that the paper on
which the items are printed can be recycled and used again in future printing
orders. However, the items appear not to be recyclable as they are coated in
plastic. The junior who performed the audit work on inventory has
requested a written representation from management to confirm that the
items can be recycled and no further procedures relevant to these items
have been performed.
(ii)
11
Questions
Procurement procedures
We found during our testing of trade payables that an approved supplier list is not
maintained, and invoices received are not always matched back to goods received
notes. This was mentioned to the procurement manager, who said that suppliers
are switched fairly often, depending on which supplier is the cheapest, so it would
be difficult to maintain an up-to-date approved supplier list.
Financial controller
Mia Fern, Willows financial controller, owns a holiday home overseas. It appears
that she offered the audit team free use of the holiday home for three weeks after
the audit, as a reward for the team's hard work. She also bought lunch for the
audit team on most days.
Required
(1)
Evaluate the audit implications of the three issues related to the audit work
raised by the audit senior. You should consider the sufficiency of evidence
obtained, any necessary adjustments to the financial statements and the
impact on the audit report if any necessary adjustments are not made.
(18 marks)
(2)
Advise on the matters, other than the three issues related to the audit work
raised by the audit senior, which should be brought to the attention of
Willows audit committee.
(7 marks)
(LO 4.1.1, 4.2.1, 4.3.1, 4.4.1, 1.3.1)
(Total = 25 marks)
8 Colombo
45 mins
You are a manager in Sambora & Co, responsible for the audit of the Colombo
Group (the Group), which is listed. The Group's main activity is steel
manufacturing and it comprises a parent company and five subsidiaries. Sambora
& Co currently audits all components of the Group.
You are working on the audit of the Group's financial statements for the year
ended 30 June 20X2.
At the planning stage, materiality was initially determined to be Rs. 900,000, and
was calculated based on the assumption that the Colombo Group is a high risk
client due to its listed status. During the audit, a number of issues arose which
meant that it was necessary to revise the materiality level for the financial
statements as a whole. The revised level of materiality is now determined to be Rs.
700,000. One of the audit juniors was unsure as to why the materiality level had
been revised.
12
CA Sri Lanka
Questions
The audit senior has provided you with the draft consolidated financial statements
and accompanying notes which summarise the key audit findings and some
background information.
The Group's draft consolidated financial statements, with notes referenced to key
audit findings, are shown below.
DRAFT CONSOLIDATED STATEMENT OF PROFIT OR LOSS AND OTHER
COMPREHENSIVE INCOME
30 June 20X2 30 June 20X1
Notes
Draft
Actual
Rs'000
Rs'000
1
98,795
103,100
Revenue
(75,250)
(74,560)
Cost of sales
23,545
28,540
Gross profit
2
(14,900)
(17,500)
Operating expenses
8,645
11,040
Operating profit
1,010
900
Share of profit of associate
(380)
(340)
Finance costs
9,275
11,600
Profit before tax
(3,200)
(3,500)
Taxation
6,075
8,100
Profit for the year
Other comprehensive income/expense for
the year, net of tax:
3
800
CA Sri Lanka
Revenue has been stable for all components of the Group with the exception
of one subsidiary, Galle Plc, which has recognised a 25% decrease in
revenue.
Operating expenses for the year to June 20X2 is shown net of a profit on a
property disposal of Rs. 2 million. Our evidence includes agreeing the cash
receipts to bank statement and sale documentation, and we have confirmed
that the property has been removed from the non-current asset register.
13
Questions
The property revaluation relates to the Group's head office. The audit team
have not obtained evidence on the revaluation, as the gain was immaterial
based on the initial calculation of materiality.
14
CA Sri Lanka
Questions
Notes
Current liabilities
Trade and other payables
Provisions
Total current liabilities
Total liabilities
Total equity and liabilities
30 June
20X2
Draft
Rs'000
30 June
20X1
Actual
Rs'000
6,200
2,700
8,900
64,670
118,420
7,300
2,800
10,100
55,700
104,100
The assets held for sale relate to a trading division of one of the subsidiaries,
which represents one third of that subsidiary's net assets. The sale of the
division was announced in May 20X2, and is expected to be complete by
31 December 20X2. Audit evidence obtained includes a review of the sales
agreement and confirmation from the buyer, obtained in July 20X2, that the
sale will take place.
A loan of Rs. 8 million was taken out in October 20X1, carrying an interest
rate of 2%, payable annually in arrears. The terms of the loan have been
confirmed to documentation provided by the bank.
Required
(1)
(2)
Evaluate whether the key audit findings indicate a risk of misstatement and
the adequacy of audit evidence obtained.
(20 marks)
CA Sri Lanka
(Total = 25 marks)
15
Questions
9 Banana
45 mins
You are a manager in Grape & Co. You have been temporarily assigned as audit
manager to the audit of Banana Pvt Ltd (Banana), because the engagement
manager has been taken ill. The final audit of Banana for the year ended
30 September 20X9 is nearing completion, and you are now reviewing the audit
files and discussing the audit with the junior members of the audit team. Banana
designs and manufactures equipment such as cranes and scaffolding, which are
used in the construction industry. The equipment usually follows a standard
design, but sometimes Banana designs specific items for customers according to
contractually agreed specifications. The draft financial statements show revenue
of Rs. 12.5 million, net profit of Rs. 400,000, and total assets of Rs. 78 million.
The following information has come to your attention during your review of the
audit files.
During the year, a new range of manufacturing plant was introduced to the
factories operated by Banana. All factory employees received training from an
external training firm on how to safely operate the machinery, at a total cost of
Rs. 500,000. The training costs have been capitalised into the cost of the new
machinery, as the finance director argues that the training is necessary in order
for the machinery to generate an economic benefit. After the year end, Cherry Pvt
Ltd (Cherry), a major customer with whom Banana has several significant
contracts, announced its insolvency, and that procedures to shut down the
company had commenced. The administrators of Cherry have suggested that the
company may be able to pay approximately 25% of the amounts owed to its trade
payables (creditors). A trade receivable of Rs. 300,000 is recognised on Banana's
statement of financial position in respect of this customer.
In addition, one of the junior members of the audit team voiced concerns over how
the audit had been managed. The junior said the following:
'I have only worked on two audits prior to being assigned the audit team of
Banana. I was expecting to attend a meeting at the start of the audit, where the
partner and other senior members of the audit team discussed the audit, but no
meeting was held. In addition, the audit manager has been away on holiday for
three weeks, and left a senior in charge. However, the senior was busy with other
assignments, so was not always available.
16
CA Sri Lanka
Questions
'I was given the task of auditing the goodwill which arose on an acquisition made
during the year. I also worked on the audit of inventory, and attended the
inventory count, which was quite complicated, as Banana has a lot of work-inprogress. I tried to be as useful as possible during the count, and helped the
client's staff count some of the raw materials. As I had been to the inventory count,
I was asked by the audit senior to challenge the finance director regarding the
adequacy of the provision against inventory, which the senior felt was
significantly understated.
'Lastly, we found that we were running out of time to complete our audit
procedures. The audit senior advised that we should reduce the sample sizes used
in our tests as a way of saving time. He also suggested that if we picked an item as
part of our sample for which it would be time consuming to find the relevant
evidence, then we should pick a different item which would be quicker to audit.'
Required
(1)
(2)
Evaluate the matters to be considered and the audit evidence you should
expect to find during your file review in respect of:
(i)
The training costs that have been capitalised into the cost of the new
machinery
(ii)
(15 marks)
10 Retriever
(Total = 25 marks)
45 mins
Kennel & Co is the external audit provider for the Retriever Group (the Group), a
manufacturer of mobile phones and laptop computers. The Group obtained a stock
exchange listing in July 20X2. The audit of the consolidated financial statements
for the year ended 28 February 20X3 is nearing completion.
You are a manager in the audit department of Kennel & Co, responsible for
conducting engagement quality control reviews on listed audit clients. You have
discussed the Group audit with some of the junior members of the audit team, one
of whom made the following comments about how it was planned and carried out:
'The audit has been quite time-pressured. The audit manager told the juniors not
to perform some of the planned audit procedures on items such as directors'
emoluments and share capital as they are considered to be low risk. He also
instructed us not to use the firm's statistical sampling methods in selecting trade
CA Sri Lanka
17
Questions
receivables balances for testing, as it would be quicker to pick the sample based
on our own judgement.
'Two of the juniors were given the tasks of auditing trade payables and going
concern. The audit manager asked us to review each other's work as it would be
good training for us, and he didn't have time to review everything.
'I was discussing the Group's tax position with the financial controller, when she
said that she was struggling to calculate the deferred tax asset that should be
recognised. The deferred tax asset has arisen because several of the Group's
subsidiaries have been loss-making this year, creating unutilised tax losses. As I
had just studied deferred tax at college I did the calculation of the Group's
deferred tax position for her. The audit manager said this saved time as we now
would not have to audit the deferred tax figure.
'The financial controller also asked for my advice as to how the tax losses could be
utilised by the Group in the future. I provided her with some tax planning
recommendations, for which she was very grateful.'
In addition, the audit committee of the Group has contacted Kennel & Co to discuss
an incident that took place on 1 June 20X3. On that date, there was a burglary at
the Group's warehouse where inventory is stored prior to despatch to customers.
CCTV filmed the thieves loading a lorry belonging to the Group with boxes
containing finished goods. The last inventory count took place on 30 April 20X3.
The Group has insurance cover in place and Kennel & Co's internal audit service
has been asked to undertake a special investigation in order to determine the
amount to be claimed in respect of the burglary. The insurance covers the cost of
assets lost as a result of thefts.
It is thought that the amount of the claim will be immaterial to the Group's
financial statements, and there is no ethical threat in Kennel & Co's internal audit
services providing the services requested.
Required
(1)
Evaluate the quality control, ethical and other professional matters arising
in respect of the planning and performance of the group audit. (14 marks)
(2)
(3)
18
(Total 25 marks)
CA Sri Lanka
Questions
11
Dragon Group
45 mins
You are a newly-qualified audit supervisor in Unicorn & Co, a global firm of
Chartered Certified Accountants, with offices in over 150 countries across the
world. You work in a department within the firm which specialises in the audit of
retail companies.
Unicorn & Co has been invited to tender for the Dragon Group audit (including the
audit of all subsidiaries). The Dragon Group is a large group of companies
operating in the furniture retail trade. The group has expanded rapidly in the last
three years, by acquiring several subsidiaries each year. The management of the
parent company, Dragon Plc, has decided to put the audit of the group and all
subsidiaries out to tender, as the current audit firm is not seeking re-election. The
financial year end of the Dragon Group is 30 September 20X9. A senior partner in
your department has recently held a meeting with the group finance director, in
which the current group structure, recent acquisitions and the groups plans for
future expansion were discussed. The partner has produced the following notes of
this meeting.
Meeting notes Dragon Group
Group structure
The parent company owns 20 subsidiaries, all of which are wholly owned. Half of
the subsidiaries are located in this country, and half overseas. Most of the foreign
subsidiaries report under the same financial reporting framework as Dragon Plc,
but several prepare financial statements using local accounting rules.
Acquisitions during the year
Two companies were purchased in March 20X9, both located in this country:
CA Sri Lanka
Mermaid Pvt Ltd, a company which operates 20 furniture retail outlets. The
audit opinion expressed by the incumbent auditor on the financial
statements for the year ended 30 September 20X8 was modified by a
material misstatement over the non-disclosure of a contingent liability. The
contingent liability relates to a court case which is still ongoing.
19
Questions
Other matters
The acquisitive strategy of the group over the last few years has led to significant
growth. Group revenue has increased by 25% in the last three years, and is
predicted to increase by a further 35% in the next four years as the acquisition of
more subsidiaries is planned. The Dragon Group has raised finance for the
acquisitions in the past by becoming listed on the stock exchanges of three
different countries. A new listing on a foreign stock exchange is planned for
January 20Y0. For this reason, management would like the group audit completed
by 31 December 20X9.
At the meeting the finance director of Dragon requested whether, if Unicorn & Co
were appointed as auditors, a certain audit senior, Kia Nelson, could be assigned
to the audit team. On further investigation it transpires that Kia Nelson is the
sister of Dragons financial controller.
Required
(1)
(2)
Evaluate the matters that should be considered before accepting the audit
engagement, in the event of Unicorn & Co being successful in the tender.
(8 marks)
(3)
Evaluate the ethical and other professional issues raised in respect of the
finance directors request for Kia Nelson to be included in the audit team.
(5 marks)
12 Lapwing
(Total = 25 marks)
45 mins
You are a manager in Lapwing & Co. One of your audit clients is Hawk Plc (Hawk)
which operates commercial real estate properties typically comprising several
floors of retail units and leisure facilities such as cinemas and health clubs, which
are rented out to provide rental income.
Your firm has just been approached to provide an additional engagement for
Hawk, to review and provide a report on the company's business plan, including
forecast financial statements for the 12-month period to 31 May 20X3. Hawk is in
the process of negotiating a new bank loan of Rs. 30 million and the report on the
business plan is at the request of the bank. It is anticipated that the loan would be
advanced in August 20X2 and would carry an interest rate of 4%. The report
would be provided by your firm's business advisory department.
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Questions
Extracts from the forecast financial statements included in the business plan are
given below.
STATEMENT OF PROFIT OR LOSS (EXTRACT)
Notes
Revenue
Operating expenses
Operating profit
Profit on disposal of Beak Retail
Finance costs
Profit before tax
FORECAST
12 months to
31 May 20X3
Rs'000
25,000
(16,550)
8,450
4,720
(2,650)
10,520
UNAUDITED
12 months to
31 May 20X2
Rs'000
20,600
(14,420)
6,180
(1,690)
4,490
Notes
FORECAST
31 May 20X3
Rs'000
UNAUDITED
31 May 20X2
Rs'000
330,150
293,000
500
3,600
2,250
6,350
336,500
450
3,300
3,750
7,500
300,500
105,000
93,400
198,400
100,000
92,600
192,600
82,500
50,000
52,500
50,000
5,600
138,100
336,500
5,400
107,900
300,500
Assets
Non-current assets
Property, plant and equipment
Current assets
Inventory
Receivables
Cash and cash equivalents
Total assets
Equity and liabilities
Equity
Share capital
Retained earnings
Total equity
Non-current liabilities
Long-term borrowings
Deferred tax
Current liabilities
Trade payables
Total liabilities
Total equity and liabilities
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Notes
1
Hawk Plc is planning to invest the cash raised from the bank loan in a new
retail and leisure park which is being developed jointly with another
company, Kestrel Plc.
Required
(1)
Evaluate the matters that should be considered in agreeing the terms of the
engagement to provide a report on Hawks business plan.
(7 marks)
(2)
(3)
Advise on the ethical issues which are relevant when providing other
services to an audit client.
(5 marks)
13 Baltimore
(Total = 25 marks)
45 mins
You are a manager in the business advisory department of Goleen & Co. Your firm
has been approached to provide assurance to Baltimore Plc (Baltimore), a
company which is not an audit client of your firm, on a potential acquisition. You
have been given the following information.
Baltimore is a book publisher specialising in publishing textbooks and academic
journals. In the last few years the market has changed significantly, with the
majority of customers purchasing books from online sellers. This has led to a
reduction in profits, and the company has recognised that it needs to diversify its
product range in order to survive. As a result of this, Baltimore has decided to
offer a subscription-based website to customers, which would provide the
customer with access to its full range of textbooks and journals online.
On investigating how to set up this website, Baltimore found that it lacked
sufficient knowledge and resources to develop this themselves and began to look
for another company which had the necessary skills, with a view to acquiring the
company. It has identified Mizzen Pvt Ltd (Mizzen) as a potential acquisition, and
has approached the bank for a loan which will be used to finance the acquisition if
it goes ahead.
Baltimore has not previously acquired another company.
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(ii)
(iii) The company has built up several customer databases which are made
available, for a fee, to other companies for marketing purposes. This is the
smallest revenue stream, accounting for approximately 20% of Mizzen's
total revenue.
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Questions
Revenue
Operating expenses
Operating profit/(loss)
Finance costs
Profit/(loss) before tax
Tax expense
Profit/(loss) for the year
1,900
1,190
610
(500)
(475)
(300)
(140)
890
470
(500)
1,425
Advise on the matters which you would focus on in your due diligence
review and recommend the additional information which you will need to
perform your work.
(17 marks)
(2)
Advise on the type of conclusion which would be issued for a due diligence
report in comparison to an audit report.
(3 marks)
(3)
24
(Total = 25 marks)
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14 Apricot
45 mins
Your audit client, Apricot Plc, is intending to purchase a new warehouse at a cost
of Rs. 500,000. One of the directors of the company, Pik Choi, has agreed to make
the necessary finance available through a director's loan to the company. This
arrangement has been approved by the other directors, and the cash will be
provided on 30 March 20X0, one day before the purchase is due to be completed.
Pik's financial advisor has asked to see a cash flow projection of Apricot Plc for the
next three months. Your firm has been asked to provide an assurance report to
Pik's financial advisor on this prospective financial information.
The cash flow forecast is shown below.
January
20X0
Rs'000
February 20X0
Rs'000
March
20X0
Rs'000
125
580
135
600
140
625
(410)
(100)
(175)
(425)
(100)
(175)
(425)
(100)
(175)
(80)
(35)
(60)
500
(500)
(15)
100
85
(45)
85
40
5
40
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Customers who pay in cash receive a 10% discount. Analysis has been
provided showing that for sales made on credit, 20% of customers pay in the
month of the sale, 60% pay after 45 days, 10% after 65 days, 5% after 90
days, and the remainder are bad debts.
Apricot Plc pays for all purchases within 30 days in order to take advantage
of a 12% discount from suppliers.
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Overheads are mainly property rentals, utility bills, insurance premiums and
general office expenses.
Apricot Plc needs to have a health and safety licence as it sells food. Each
licence is valid for one year and is issued once an inspection has taken place.
A profit forecast has also been prepared for the year ending
31 December 20X0 to help with internal planning and budgeting.
During this year, Apricot Plc established a pension plan for its directors, and this
year end the company will be recognising a pension deficit on the statement of
financial position for the first time, in accordance with LKAS 19 Employee benefits.
The finance director of Apricot Plc has contacted the audit engagement partner,
asking if your firm can provide a valuation service in respect of the amount
recognised.
Required
(1)
(2)
Advise on the main contents of the report that will be issued on the
prospective financial information.
(5 marks)
(3)
(4)
Evaluate the ethical and professional issues raised in respect of the request
regarding the provision of a valuation service.
(5 marks)
15 Beech
(Total = 25 marks)
45 mins
You are a manager in the audit department of Beech & Co, responsible for the
audits of Fir Plc (Fir), Spruce Plc (Spruce), Pine Plc (Pine) and Oak Plc (Oak). Each
company has a financial year ended 31 July 20X1, and the audits of all companies
are nearing completion. The following issues have arisen in relation to the audit of
accounting estimates and fair values.
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Questions
(1)
Fir Plc
Fir is a company involved in energy production. It owns several nuclear
power stations, which have a remaining estimated useful life of 20 years. Fir
intends to decommission the power stations at the end of their useful life
and the statement of financial position at 31 July 20X1 recognises a material
provision in respect of decommissioning costs of Rs. 97 million (20X0
Rs. 110 million). A brief note to the financial statements discloses the
opening and closing value of the provision but no other information is
provided.
Required
Evaluate the matters that should be considered, and the audit evidence you
should expect to find in your file review in respect of the decommissioning
provision.
(8 marks)
(2)
Spruce Plc
Spruce is also involved in energy production. It has a trading division which
manages a portfolio of complex financial instruments such as derivatives.
The portfolio is material to the financial statements. Due to the specialist
nature of these financial instruments, an auditor's expert was engaged to
assist in obtaining sufficient appropriate audit evidence relating to the fair
value of the financial instruments. The objectivity, capabilities and
competence of the expert were confirmed prior to their engagement.
Required
Advise of the procedures that should be performed in evaluating the
adequacy of the auditor's expert's work.
(5 marks)
(3)
Pine Plc
Pine operates a warehousing and distribution service, and owns 120
properties. During the year ended 31 July 20X1, management changed its
estimate of the useful life of all properties, extending the life on average by
ten years. The financial statements contain a retrospective adjustment,
which increases opening non-current assets and equity by a material
amount. Information in respect of the change in estimate has not been
disclosed in the notes to the financial statements.
Required
Advise of the potential implications for the auditor's report of the
accounting treatment of the change in accounting estimates.
(5 marks)
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27
Questions
(4)
Poppy Plc
Poppy Plc, is a manufacturing company. In the last year, several investment
properties have been purchased to utilise surplus funds and to provide
rental income. The properties have been revalued at the year end in
accordance with LKAS 40 Investment property, they are recognised on the
statement of financial position at a fair value of Rs. 8 million, and the total
assets of Poppy are Rs. 160 million at 31 July 20X1. An external valuer has
been used to provide the fair value for each property.
Required
Propose the principal audit procedures to be performed on the valuation of
the investment properties.
(7 marks)
Note. Assume it is 5 December 20X1.
(LO 4.1.1, 3.4.1)
16 Seatown
(Total = 25 marks)
45 mins
Seatown is located on the coast. The towns main industry is tourism with an
emphasis on family holidays and consequently the cleanliness of the towns
beaches is a major factor in the towns success.
The town council, which is the local government authority, has a cleaning
department that is responsible for keeping the beaches clean and tidy. Early every
morning, after the tide has gone out, the beaches are swept, using equipment that
is towed behind tractors. This equipment skims the top layer of sand and runs it
through a filter to remove any litter, before returning the cleaned sand to the
beach. Most of the litter is paper and plastic packaging which tourists have
discarded, but the litter can include glass bottles and aluminium cans.
To try to prevent litter being left on the beach the town council also places bins on
the beaches above the high water mark. Litter bins need to be emptied regularly,
otherwise holidaymakers pile their rubbish beside the bins and that leads to litter
being spread by the wind or by seabirds scavenging for food scraps.
The cost of cleaning the beaches is a major expense for the town council. The
management team of the town council has asked the internal audit department to
investigate whether the town is getting good 'value for money' from this
expenditure. The head of internal audit has sought clarification from the town
managers on whether the audit should focus on the economy and efficiency of the
cleaning operations or their effectiveness. Economy and efficiency audits generally
focus on whether cost can be reduced for the same level of service and
effectiveness audits ask whether better service can be achieved for the same cost.
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Required
(1)
Advise, giving reasons, the matters that the town councils internal audit
department should study in order to evaluate the economy and efficiency of
the beach cleaning activities.
Your answer should include advice on how to obtain the necessary data and
information.
(12 marks)
(2)
Recommend, giving reasons, the matters that the town councils internal
audit department should study in order to evaluate the effectiveness of the
beach cleaning activities.
Your answer should include advice on how to obtain the necessary data and
information.
(13 marks)
17 WWW
(Total = 25 marks)
45 mins
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However, many of the documents covered by the court order were the subject of
confidentiality agreements between WWW and various entrepreneurs. These
documents included details of patents and processes with a high commercial value
and if knowledge of these became public it would destroy some of WWWs
competitive advantage.
Situation 3
This situation, which is unconnected to Situations 1 and 2, has also occurred.
WWW has a joint venture agreement with a company, ZZZ. Under the terms of the
joint venture agreement each company has to make regular returns of financial
performance to the other. ZZZ is always late in making its returns, which are
usually incomplete and contain many errors. ZZZ's accounting staff are very
reluctant to co-operate with WWWs accounting staff and the working relationship
between the two companies is poor.
WWWs financial controller has been involved in a review of the joint venture with
ZZZ. Due to the many problems that ZZZ has caused him and his staff he has
advised discontinuing the joint venture.
Required
(1)
(2)
30
(5 marks)
(5 marks)
(5 marks)
(Total = 25 marks)
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Questions
18 VV
45 mins
The options are issued 'at the money' (that is, the exercise price is the same
as the market price) so that the directors have an incentive to increase the
share price.
The options can only be exercised on a specified date that falls three years
after their issue.
If a director leaves the company then any outstanding options will lapse
without compensation.
The institutional investor has expressed concern about the ESOS arrangement
because of the underlying financial implications of the scheme. VV first introduced
ESOSs in order to motivate the executive directors to act in the shareholders
interests. If the directors work towards maximising VVs share price then the
options will provide higher returns if they are in the money when they come due
for exercise. In addition, VVs directors are much less likely to reject positive net
present value investment opportunities if they hold options. Normally the
directors are more risk averse than the shareholders when it comes to project
appraisal, but holding options makes risk-taking more appealing.
The institutional investor is concerned that the options may have encouraged
dysfunctional behaviour by the directors, although it is difficult to be certain that
that has arisen because of the limited information that is available to the
shareholders.
The institutional investor has suggested that the executive directors should be
rewarded with a simpler scheme, such as an annual profit-related bonus. At
present, it is unclear whether the reward system in place provides the executive
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31
Questions
(2)
(i)
(ii)
Explain how an ESOS scheme could affect the actions taken by the
directors (other than the project appraisal decision).
(8 marks)
32
(Total = 25 marks)
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Questions
Section 2
1 Daily Newspapers
90 mins
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33
Questions
Mission statement
Daily plc's mission is 'to be the best news media organisation in Asia, providing
quality reporting and information on Asian and world-wide events'.
Strategic objectives
Four main strategic objectives were established ten years ago by Daily plc's Board
of Directors. These are to:
1
Meet the needs of readers for reliable and well informed news.
Publish some newspapers which help meet the needs of native English
speakers who live in countries which do not have English as their first
language.
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CA Sri Lanka
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significantly in recent years and have attracted the attention of Daily plc's
internal audit department.
There has been significant capital investment in the Newspapers Division since
20X9/X0. The long-term borrowings of the company include HK$83 million of
loan capital which is due for repayment on 1 April.
Web Division
The web versions of the newspapers are shorter versions of the printed ones.
There is currently no charge for access to the web versions of the newspapers.
Revenues are generated from sales by the Advertising Division of advertising
space on the web pages. Some of the websites permit comments from the public
to be posted on them and they have proved to be very popular. The Web
Division is undertaking a review of all its costs, particularly those relating to
energy, employees and website development.
Advertising Division
The Advertising Division remits advertising revenue to both the Newspapers
and Web Divisions after deducting its own commission. In addition, the
Advertising Division offers an advertising service to corporate clients. Such
services include television and radio advertising and poster campaigns on bill
boards. Advertisements are also placed in newspapers and magazines which are
not produced by Daily plc, if the client so wishes. An increasing element of the
work undertaken by the Advertising Division is in providing pop-up
advertisements on websites.
The Board of Directors and group shareholding
Daily plc's Board of Directors comprises six executive directors and six nonexecutive directors, one of whom is the Non-executive Chairman. The executive
directors are the Chief Executive, and the Directors of Strategy, Corporate
Affairs, Finance, Human Resources and Business Development. There are
divisional managing directors for each of the three divisions who are not board
members but report directly to the Chief Executive.
Some board members feel that the newspapers market is declining because
fewer people can make time to read printed publications. Some of the nonexecutive directors think that many people are more likely to watch a television
news channel than read a newspaper.
Editorial policy
Daily plc's board applies a policy of editorial freedom provided that the
published material is within the law and is accurate. The editors of each of the
publications printed in HK and FR and of the websites have complete autonomy
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35
Questions
over what is published. They are also responsible for adhering to regulatory
constraints and voluntary industry codes of practice relating to articles and
photographs which might be considered offensive by some readers.
There is less scrutiny of the accuracy of the reporting in N's home country than
in other countries. The country has become politically unstable in the last two
years. Much of this unrest is fuelled by the public distaste for the perceived
blatant corruption and bribery which is endemic within the country's
Government and business community. It is well known that journalists have
accepted bribes to present only the Government's version of events, rather than
a balanced view. There is also widespread plagiarism of published material by
the country's newspapers and copyright laws are simply ignored.
Corporate Social Responsibility
A policy is in place throughout Daily plc in order to eliminate bribery and
corruption among staff especially those who have front line responsibility for
obtaining business. This policy was established 15 years ago. All new employees
are made aware of the policy and other staff policies and procedures during
their induction. The Director of Human Resources has confidence in the
procedures applied by his staff at induction and is proud that no action has ever
been brought against an employee of Daily plc for breach of the bribery and
corruption policy.
Daily plc is trying to reduce its carbon footprint and is in the process of
developing policies to limit its energy consumption, reduce the mileage
travelled by its staff and source environmentally friendly supplies of paper for
its printing presses.
Unseen case material
The following information relates to Daily plc.
Web site
Daily plc publishes a Sunday newspaper that is popular throughout the UK. The
newspaper has recently launched an online version which can be downloaded by
subscribers who pay a monthly fee that is slightly less expensive than buying the
printed version of the newspaper. There are approximately 80,000 subscribers to
this service.
The online version of the newspaper allows subscribers to post comments
concerning any of the articles published in the most recent version of the
newspaper. This has been a popular facility that readers appear to value. There
has been an average of 15,000 posts per week since the posting facility was
introduced.
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Subscribers must log in using their user names and passwords before they can
make a post. Daily plc does not edit such posts because it would be prohibitively
expensive to do so. Instead, Daily plc relies on software that scans each draft post
for offensive language and any post that does not trigger that software appears in
a text box underneath the article and can be read by all subscribers.
Subscribers to the online version of this newspaper must register using a credit
card in order to obtain a subscription. They have to tick a box onscreen to
acknowledge that they have read and agreed to Daily plcs terms and conditions,
which include the following.
Subscribers accept Daily plc is not responsible for any offensive or incorrect
comments posted on the site.
Subscribers agree that any posts they place on the site will be honest, accurate
and not intended to cause any harm or offence. Authors agree that all
responsibility for comments they post remains with the author not Daily plc.
The copyright to all posts to the site belongs to Daily plc and nobody is
permitted to copy, print or publish them for any purpose without first
seeking Daily plcs permission.
Last month a post was made underneath an article about J, a famous pop singer,
who endorses a range of vegetarian meals. The posts author claimed to have seen
J eating a meat dish in a restaurant. The post was read and copied by a journalist
from a rival newspaper. The journalist sought reactions from J and the
manufacturer of the vegetarian meals and published the story on the front page of
the Monday edition of the rival newspaper under the headline 'Famous vegetarian
eats principles'. The article was careful to state that the only foundation for the
story is the post to Daily plcs site.
Js lawyers have contacted Daily plc to inform the company that the vegetarian
meals manufacturer has cancelled Js advertising contract. J is seeking
compensation from Daily plc for the loss of these earnings and also for the damage
to her reputation. Daily plc has rejected the claim on the grounds that it had taken
all reasonable steps to prevent any harm to Js reputation when it drafted its terms
and conditions. The offending post was removed from the site as soon as it was
drawn to Daily plcs attention.
Expenses audit
Daily plcs directors receive monthly management accounts which show major
categories of income and expenditure. The level of journalists expenses has been
growing dramatically. The Board of Directors has insisted that the internal audit
department carry out regular reviews of the journalists expenses starting as soon
as possible.
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37
Questions
The directors also asked the Head of Internal Audit to investigate immediately the
increase in journalists expenses. The investigation revealed no evidence of fraud
but did uncover a culture in which job-related expenses were being incurred with
no regard to the cost. For example, if a journalist wished to conduct an interview
outside of a contacts office for the sake of privacy, it had become accepted that the
interview would be conducted in an expensive restaurant. Journalists make their
own travel arrangements: this was considered to be necessary in order to avoid
slowing down work on a breaking story. It had become common practice for all
rail journeys to be booked first class and all flights to be taken in business class
even though that cost a great deal more than standard or economy class travel.
Overnight stays tended to be booked in five star hotels.
Journalists had also claimed for items of equipment ranging from mobile phones
and laptops to expensive televisions and office furniture for home offices. They
usually bought the latest and most expensive technology and justified it on the
basis that it would make news gathering more efficient.
Expense claims must be submitted on official claim forms with receipts attached.
Each claim must be signed by the journalists editor before the accounts
department will process it. Editors told the Head of Internal Audit that journalists
attitudes had changed over the past four or five years and that they were making
ever more substantial claims. Editors did not wish to risk demotivating journalists
by restricting expenses and so spending had tended to escalate.
Daily plc has a formal policy on expenses, with guidance on the maximum costs
that can be incurred for entertaining or travel without seeking specific approval.
The investigation found that no one in the company has paid any attention to that
policy.
Wood pulp
Paper is manufactured from wood pulp. Wood pulp is a commodity that is traded
around the world at prices set in USD. That means that Daily plc is quite heavily
exposed to fluctuations in the USD exchange rate against HK$ because paper is one
of the companys biggest expenses.
Daily plcs board reviews its policies on currency risk on a regular basis. It has called
for a discussion of three possible methods of managing the companys exposure:
Switch to a HK supplier
There are three or four HK-based paper manufacturers with which Daily plc
could do business. Daily plc buys paper in such large quantities that the
Production Director believes that it will be possible to negotiate a contract
under which the manufacturer will offer a price set in HK$ that will be fixed
for, say, three years.
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Invest in USD
Daily plc has a small cash reserve that it can increase by borrowing a
substantial amount in HK$. If the resulting balance is deposited in a USD bank
account then the interest received will go some way to compensating for the
increased cost of borrowing. If the USD strengthens then the deposit will
appreciate in value and that will compensate for the additional cost of paper.
Required
(1)
(2)
(i)
(ii)
(i)
(ii)
Explain the difficulties that could arise from the boards directive that
the internal audit department should carry out regular reviews of
journalists expenses. Include in your discussion the role of the internal
auditor and a chief risk officer within the enterprise management
system structure.
(7 marks)
(LO 2.5.1, 2.3.1, 2.1.1, 2.1.2, 2.1.3, 2.2.1, 2.6.1, 2.2.2, 2.4.1)
CA Sri Lanka
(Total = 50 marks)
39
Questions
2 Farama 1
90 mins
40
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Questions
Strategic aims
The strategic aims are set in order to enable F plc to meet the obligations
contained in its mission statement.
F plc aims to:
(a)
(b)
(c)
Ensure that its factories adhere to the highest standards of food hygiene
which guarantee the quality of its products
(d)
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41
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Snacks Division
The Snacks Division, located in the East of Farama, mainly manufactures
confectionery such as packet savouries and chocolate bars. Its main customers are
supermarkets and retail shops. It has a growing overseas market and last year
earned 19% of its revenue from export sales. Many of its products are F plcs own
brands, although, similarly with the Meals Division, it supplies products to
supermarkets under their own label.
Desserts Division
The Desserts Division is located in the North of Farama where road, rail and air
links are not well developed. This has resulted in high transportation costs for
goods into and out of the factory.
The Divisions sales increase in the periods which lead up to national and
international festive periods. The Division is constantly researching new markets
in an effort to increase its foreign earnings. Revenue from exports represented
23% of the Divisions total revenue last year.
Inventory control and IT systems
There have been a number of problems across all three divisions in respect of
inventory control. Poor inventory control has led to high levels of wastage and
obsolete inventory being carried. This has been particularly problematic in
respect of perishable ingredients. In the case of the Desserts Division, the
Divisional Accountant has estimated that 5% of the Divisions potential revenue
has been lost as a result of not being able to satisfy customer orders on time, due
to poor inventory control.
Internal audit
Until now, F plcs Internal Audit function, which is based at Head Office, has
tended to concentrate its efforts on reviewing activities in the Meals and Snacks
divisions as they each produce lower revenues and net operating profits in
absolute terms compared with the Desserts division. The Internal Audit functions
approach of applying a 'light touch' to the Desserts Division is also in recognition
of the influence exerted by the Divisional Finance function over the Divisions
operational activities.
Strategic development
The Board of Directors is now midway through its strategic planning cycle and is
considering how the company should move forward. There is a proposal to build
and operate a factory in West Africa to reduce air kilometres being flown in
supplying the Meals Division with fresh vegetables. It is intended that the African
factory will freeze the vegetables and then transport them to the Meals Divisions
factory in England by refrigerated ship.
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43
Questions
APPENDIX 1
Extracts from F plcs internal Corporate Social Responsibility report
This report was produced by the Environmental Effects Manager and presented to
the Board of F plc in January 20X1.
Fair trading
In accordance with its mission statement, F plc is committed to paying a fair price
for the ingredients it uses in its products, particularly to farmers in the less
developed economies of the world.
Food labelling
Legal requirements demand accuracy in food labelling, in respect of ingredients,
product description and cooking instructions in many countries. F plc employs a
Compliance Manager to ensure that relevant labelling laws in each country, with
which the company trades, are adhered to. A target is set for F plc to justify 100%
of its claims in food labelling. Two products manufactured in the Meals Division
are currently undergoing investigations by the Food Standards Authority of a
European country following allegations that the labelling is inaccurate.
Transportation
Following adverse press coverage relating to the high number of kilometres
travelled when importing and exporting goods from and to overseas countries, F
plc introduced a target that its use of air travel should be reduced by 10% in 20X0
compared with the amount used in the previous year.
Unseen case material
African factory
F plcs Meals Division also produces frozen vegetables. Fresh vegetables are
purchased from farmers in West Africa because the climate there enables
vegetables to be grown throughout the year.
Fresh vegetables are flown to the United Kingdom within 24 hours of being
harvested. The vegetables are perishable and therefore must be processed and
frozen within hours of arriving in the UK. After they have been frozen the
vegetables are packaged and stored ready for sale.
F plcs board has decided to build a factory in West Africa to process the
vegetables. Fresh vegetables will be delivered to the factory, where they will be
processed and packaged in the same way as they are in the UK factory. The
packaged vegetables will then be transported in refrigerated shipping containers
to the UK and will be ready for immediate sale.
The board of F plc believes that building a factory in West Africa will demonstrate
a commitment to sound corporate social responsibility. The factory will create
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jobs in the West African country and so more of the wealth created by its farmers
will circulate in the local economy. Furthermore, environmentalists will have
fewer objections to shipping than air freighting.
There will be no significant difference in the total cost of manufacturing and
transporting the finished product compared to the present arrangements.
Staffing
The factory will be highly mechanised and therefore most of the labour will be
unskilled. Manual workers are needed to move vegetables and finished products.
The staffing plan prepared by the Director of Operations shows that the unskilled
labour will be recruited locally in West Africa.
However, there are some posts that require staff with considerable education and
training. For example, the UK factory currently employs several qualified food
technicians who have university degrees. They are responsible for testing batches
of vegetables when they arrive to ensure that they are suitable for freezing. This
work is very important because factors such as the water content and acidity of a
batch of vegetables can affect the quality of the final product. There is also a
significant number of skilled supervisors who are responsible for quality control,
health and safety and other tasks.
The staffing plan shows that the skilled posts will initially be filled by sending staff
from the UK factory to West Africa. It is proposed that the staff will work for four
weeks in West Africa and then be flown home for two weeks of leave before being
flown back to West Africa for another four weeks. The Director of Operations has
planned for this pattern to continue for the first two years. During this period F plc
will work with local West African colleges to develop intensive courses on food
technology, management and other skills to provide a local pool of skilled labour
with the required qualifications.
F plc has already determined that there are local colleges that teach relevant
subjects and so there is the basis of an educational programme. It would not be
particularly expensive for F plc to sponsor courses at these colleges so that they
could develop their course content to ensure that Fs requirements are met in
terms of both syllabus coverage and rigorous assessment.
At the end of the two year transitional period, the UK staff will either be
transferred to other posts in the UK or they will be made redundant.
When the proposal to transfer production was announced the UK skilled staff
were unhappy with the planned arrangements. Many of them have said that they
will not work in West Africa because the proposed work patterns are too
disruptive to family life and that F plc will either have to find them suitable
alternative employment in the UK or make them redundant.
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Information systems
Inventory management is very important for the success and profitability of
producing frozen vegetables. Frozen vegetables can be stored for a very long time
but it is expensive to do so and therefore inventory levels are closely monitored
and managed through the Meals Divisions information system. Sometimes major
customers are offered substantial discounts in order to clear inventory and
thereby reduce holding costs.
The inventory management system will need to be adapted significantly when
production is transferred to West Africa because additional data will have to be
collected at the West African factory and also when finished goods are loaded onto
ships in refrigerated shipping containers.
Finance
F plc has the choice of two ways to fund the investment needed for the factory in
West Africa:
The company has banked with a UK commercial bank for many years and the
bank has offered to grant a loan denominated in GBP. The loan would be
secured against F plcs UK assets.
The government of the West African country has also offered to make a loan
for the same amount, but denominated in the local currency. The loan would
be secured against the West African factory.
Risk evaluation
F plc has a policy of conducting all formal risk evaluations in accordance with a
Risk Management Cycle. The first four stages of the cycle are:
Set goals
Identify risk areas
Understand and assess scale of risk
Develop risk response strategy
Required
(1)
46
F plcs directors are concerned about the risks to F plcs reputation arising
from moving production to West Africa.
(i)
(ii)
(8 marks)
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Questions
(2)
Governance
Staffing
Support facilities
Course content
(10 marks)
(3)
Advise the board on the controls necessary during the development and
implementation of the changes to the inventory management system.
(12 marks)
(4)
Evaluate both the currency and the non-currency risks associated with each
of the two loan packages for the financing of the West African factory.
(12 marks)
3 Farama 2
(Total = 50 marks)
90 mins
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Questions
The Meals Division conducted its own analysis of the meals purchased by the
charity. The presence of the bacteria was confirmed, but it was found to be a
common organism that is present in almost all meat. If the charity had cooked the
frozen meals in accordance with the instructions printed on the packaging then
the bacteria would have been killed and the consumers would not have been
harmed in any way. Furthermore, the contamination was only very slight. A
healthy person who ate a meal containing small quantities of these bacteria would
not become ill because of the bodys immune system.
This case has been reported widely in newspapers and on television. F plcs
directors have asked for an analysis of the risks to the companys reputation. The
Meals Divisions management team has recommended that F plcs defence should
be based on the following two arguments:
The frozen meals supplied by the Meals Division should not have caused any
harm unless they had been prepared negligently by the charity. The charity
should be blamed for the food poisoning and not F plc.
Secret recipe
One of F plcs most popular and profitable products is a steak pie that is flavoured
with a special gravy that was developed by one of F plcs founding family
members. The gravy is manufactured using a very specific mixture of herbs and
spices. F plcs competitors cannot copy this mixture because the ingredients have
to be combined in a very precise manner and then cooked in a particular way.
The recipe for this herb and spice mix is known only to F plcs Director of
Operations and the manager of the pie factory. There is no written record
anywhere. The factory manager has worked for F plc for more than 30 years and he
is a trusted member of staff. Twice a year, the director and the manager of the pie
factory close part of the factory to all other staff and the two of them make sufficient
quantity of the mix to last for the next six months.
The factory manager was recently offered a job by one of F plcs largest rivals. The
job would double the factory managers salary and he would be guaranteed the
opportunity to retire on full pay within two years of taking up the post. He
declined this offer and informed the Director of Operations that he received this
approach.
The chief executive of F plc is concerned that a competitor could have acquired the
factory managers knowledge of the recipe in such an easy and inexpensive
manner. He is also concerned that F plc does not have a record, other than the
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(2)
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(i)
(ii)
(i)
(ii)
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Questions
(3)
(4)
(i)
(ii)
Discuss the validity of the head of internal audits assertion that the
external auditor should be prepared to cooperate with the internal
audit department.
(6 marks)
4 Aybe 1
(Total = 50 marks)
90 mins
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Aybe's Chief Executive said in the annual report that the strategic aim is clear and
straightforward. He said 'Aybe will strive to maintain its share of the electronic
development, operational, maintenance and repair markets in which it is engaged.
This is despite the global economic difficulties which Aybe, along with its
competitors, has faced since 20X7. Aybe will continue to apply the highest ethical
standards in its business activities.'
In order to facilitate the achievement of the strategic aim, Aybe's Board has
established the following strategic goals:
1.
2.
3.
4.
The Board has also stated that Aybe is a responsible corporate organisation and
recognises the social and environmental effects of its operational activities.
Concern over the rate of growth
Aybe's recently appointed Director of Operations and one of its Non-Executive
Directors have privately expressed their concern to the Chief Executive at what
they perceive to be the very slow growth of the company. While they accept that
shareholder expectations should not be raised too high, they feel that the Board is
not providing sufficient impetus to move the company forward. They fear that the
results for the year ended 31 December 20X9 will be worse than for 20X8. They
think that Aybe should be much more ambitious and fear that the institutional
shareholders in particular, will not remain patient if Aybe does not create stronger
earnings growth than has previously been achieved.
Development approaches
The Board has discussed different ways of expanding overseas in order to meet
the overall strategic aim. It has, in the past, been reluctant to move from the
current approach of exporting components. However the Director of Operations
has now begun preparing a plan for the IEC division to open up a trading company
in Asia. The DEC division is also exploring various options on how to establish
operations in Africa. The two main options are a wholly-owned subsidiary or a
joint venture.
The Aybe group's draft consolidated financial statements for the year ended 31
December 20X9 with comparative figures are shown below:
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31 Dec 20X9
Draft
C$'000
EQUITY AND LIABILITIES
Equity
Share capital
Revaluation reserve
Retained earnings
Non-controlling interest
Total equity
Non-current liabilities
Long-term borrowings
Total non-current liabilities
Current liabilities
Trade and other payables
Provisions
Total current liabilities
Total liabilities
Total equity and liabilities
31 Dec 20X8
Actual
C$'000
110,000
13,500
33,700
18,500
175,700
110,000
13,500
29,400
17,000
169,900
51,950
51,950
35,350
35,600
10,800
15,900
26,700
78,650
254,350
9,300
9,800
19,100
54,700
224,600
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The Head of the Audit Committee has asked the Chief Internal Auditor to consider
the matter and to brief the Audit Committee on the following matters:
The approach that the internal audit department would take to the planning
and execution of post-completion evaluations. For example, how will
projects be selected for investigation and what aspects will be examined?
The Audit Committee has informed the main board of its intention to commission
post-completion evaluations. The Chief Executive is worried that some managers
might be reluctant to propose projects if they know that such actions could be
subjected to an audit.
Required
(1)
(2)
(i)
(ii)
(i)
(ii)
5 Aybe 2
(Total = 50 marks)
90 mins
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Questions
from DEC (in Aybe's home country). Payments for the components and raw
materials will be made to DEC in the currency of the African country but DEC's
accountant is concerned about the high level of inflation in the African country
and the consequent impact on future receipts. He is particularly worried because
it has been stated that the African joint venture arrangement will only make three
payments each year for components and materials and therefore each payment
will be for a high value. The share of profits from the joint venture will be remitted
to DEC on request and in accordance with any exchange control regulations of the
African country.
DEC has just received payment for all of the shipments to the African factory to
date (as stated earlier, the African joint venture arrangement will in future only
make three payments each year). The accountant has noticed that the amount
remitted was in excess of the invoice value of the goods sent to the factory. Initial
investigations show that the prices were inflated on the invoices by a manager in
DEC at the headquarters in Aybe who was attempting to increase his profit-related
bonus.
The joint venture has just started selling its output within its home country but
sales volumes are low. Export sales to other African countries have not yet
commenced and forecasts for future export sales have yet to be produced. The
product range offered by the African joint venture is similar to DEC's European
range.
The information systems within the African joint venture are not fully developed.
The priority was to set up control systems for inventory and production. These
systems became operational within the last month. Consequently the sales staff in
the joint venture is already benefiting from knowledge of inventory levels and are
able to provide accurate information to customers about product availability.
However due to over-optimistic initial sales forecasts, significant levels of
inventory have accumulated. The African sales staff are concerned that the
shortfall in sales is having an adverse impact on their bonuses because they are
not meeting their targets.
African sales staff are reluctant to offer discounts to promote sales and reduce the
excessive inventory. Their bonuses, which make up the majority of their
remuneration packages, are based on average profit per unit sold and sales
volumes.
This information system problem referred to above is not the only issue affecting
DEC's information systems in recent years. Another factory extension previously
referred to under "Capital budget overspends" was 50% overspent party due to
lack of regular checks of budget to actual costs.
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Revenue
Cost of sales
Gross profit
Operating expenses
Operating profit
Finance costs
Profit before tax
31 March
20Y0
C$'000
43,700
(27,420)
16,280
(12,600)
3,680
(1,750)
1,930
Required
(1)
CA Sri Lanka
(i)
Explain how the risk appetite of the group would have influenced the
decision to establish new operations in Africa.
(5 marks)
(ii)
Identify and evaluate FIVE risks affecting DEC's new joint venture in
Africa.
(10 marks)
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Questions
(2)
(3)
(i)
(ii)
(i)
Discuss the methods DEC and the African joint venture could use to
mitigate the foreign exchange risk when trading with other foreign
countries.
(5 marks)
(ii)
(4)
Discuss the safeguards that should exist within any company to prevent the
unethical manipulation of transactions. (You should refer to examples from
DEC in your answer.)
(10 marks)
(LO 2.1.3, 2.4.1, 3.1.1, 3.2.1, 1.4.1, 1.4.2, 2,4,1, 1.5.1, 3.4.1, 3.5.1) (Total = 50 marks)
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Section 1
1 Mahmood
(1)
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belief. Because he has had no satisfaction from his manager at Tzo, he might
believe it ethically right to inform an external source, such as a
newspaper, as he is considering. Post-conventional behaviour is often costly
to the actor and if Mahmood were to become a whistleblower in this case, he
may well lose his own job and cause others to lose theirs.
(2)
Ethical case
In recognising that it would be very costly on a personal level for Mahmood
to act as a whistleblower in this case, there is a strong ethical argument that
he should do so.
The company is acting in a concerted manner to deceive customers by
selling food which is not what they believe it to be. As an employee of the
company, Mahmood is taking part in a value adding process which results in
a product which is not what the customer thinks they are purchasing. It may
be that the inferior meat, even if safe to eat for the majority, is unsuitable for
some diets or which may offend some consumers personal or cultural
beliefs. In a trades-description sense, this deceit is a breach of customers
trust. It may cause offence to some and possibly even illness in others if they
purchased a product unaware of the inferior nature of the contents.
Because the board of Tzo Company is complicit in the decision, he is
unlikely to get any change of mind from anyone in the company. So the only
way to highlight the deceit is to go outside the company. Were he to adopt
the normal grievance procedure by observing the chain of command in the
company, the involvement of the board of Tzo Company in the use of inferior
meat would make it unlikely he would get a sympathetic hearing. In fact by
raising the issue internally, he might risk his own safety or the comfort of his
position at work. So going to a newspaper may be the only way he can
reasonably expect to see the problem addressed.
The division is falsifying quality control reports and therefore
intentionally misleading whoever it is who receives these perhaps a food
standards agency, a regulator or similar. This control is presumably intended
to ensure that the companys main output is of a high quality as stated, and
that the quality assurance measures are met for the product. The falsification
of the report means that normal quality procedures are being systematically
subverted and this is a very serious matter. Again, the fact that the board of
directors has sanctioned this makes it unlikely that Mahmood would receive
a sympathetic hearing, thus making the case for going directly to the
newspaper.
It is in the public interest to highlight a situation in which a company is
mislabelling food, deceiving customers and shareholders, and requiring its
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employees to take part in the deceit and remain quiet about it. This is not
how business should behave and it could serve to erode societys trust in
business in general. Employees have an ethical right to work for a company
which is not structurally deceitful and were such a situation to persist, it
could undermine managementemployee relations and open the company
up to legal and reputational damage. Inasmuch as such a situation is
probably likely to be disclosed eventually, a quicker rather than protracted
conclusion is preferable.
(3)
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continuing to use the meat and admitting it, or discontinuing its use in order
to report on internal controls supporting the claimed high quality of its
products. Either way, continuing to use inferior meat in a concealed way
would be very difficult.
A report on the effectiveness of internal controls (such as Sarbanes Oxley
s.404) typically requires the inclusion of a statement on the processes used
by the directors to assess the effectiveness of internal controls. This includes
the disclosure of any material internal control weaknesses or any
significant problems which the company encountered in its internal controls
over the period under review. The value of the report as a means of
reassuring investors is to use this statement to demonstrate the robustness
of the processes. An unconvincing disclosure on this would potentially
undermine investor confidence.
Because the report is subject to an auditors review (or full audit in some
jurisdictions), the auditors can demand evidence of any statement on the
report and follow any claim made back along the relevant audit trail. It is a
serious and often easily detectable offence to deceive an auditor or to make a
knowingly false statement in an audited or auditor-reviewed report. Such a
deceit (of the auditors) would result in an immediate loss of confidence in
management on the part of the auditors and, in consequence, also on the
part of shareholders and regulators
2 David
(1)
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business requests. Confidentiality may also be an issue, that the board may
be instructed to treat the request and its response as confidential.
What are the norms, principles and values related to the case?
Objectives. The board must act in accordance with the corporation's
objectives, which will be to supply electricity as economically and
efficiently as possible. The board is entitled to consider whether major
cost-cutting may increase the risk of the electricity supply failing.
Governance. As EPC is a nationalised entity, the directors are expected to
act in accordance with the wishes of the properly elected government,
since the democratic process confers legitimacy upon the government's
wishes. This means accepting major changes such as privatisation if they
wish to remain on the board, also accepting other obligations such as
keeping certain information confidential if necessary.
Independence. The duty of independence means that the board cannot
actively intervene in the political process, an issue of most relevance
during a general election campaign.
Transparency. Ultimately also the board owes a duty of transparency
about its policies to the public and consumers, as they are primary
stakeholders. However the duty of transparency is not normally regarded
as absolute; strategic business discussions may legitimately be kept
confidential in the short-term for various reasons.
What are the alternative courses of actions for the board?
Supply the information on the grounds that the board is not empowered
to refuse a legitimate request from the Ministry of Energy.
Supply the information provided that the board receives prior assurance,
certainly from the civil servants and preferably from the Minister of Energy,
that the information will not be used for political purposes during the
election campaign.
Refuse to supply the information on the grounds that the board must be
seen to be neutral when its future is a significant issue in the election
campaign.
Refuse to supply the information on the grounds that it cannot be
expected to make a major commitment to cost reduction instantly;
review and discussion of possible options will be required and this will take
time.
What is the best course of action that is consistent with the norms,
principles and values?
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The board seems to have legitimate business reasons for asking for more
time to consider cost reductions. It is also entitled to be sensitive to
independence issues and seek assurances before it supplies any
information that could help the governing party.
What are the consequences of each course of action?
If the information is supplied and then kept confidential, the board's
independence is unlikely to be questioned, although a hastily drawn up
plan may later be criticised for business reasons. If detailed information is
not supplied until the board has had the chance to consider its plans
carefully, the decisions are more likely to be in accordance with the
corporation's objectives.
If the board supplies the information and it is used for political
purposes, then the board's independence will be questioned. If the
opposition party then wins the election, some or all of the board may well be
replaced and EPC may suffer disruption to board decision-making and
monitoring. Similarly if the board refuses, the current government takes
offence and wins the election, the board may also be replaced.
What is the decision?
The board may feel able to supply some indications of how it might cut
costs. It should refuse to supply detailed information until it has had time
to consider future planning carefully, even if this means the information is
not available until after polling day. Before it supplies any information it
should seek guarantees from the governing party that it will not use the
information to forward its political platform. It should not reveal the request
has been made unless the information is used for political purposes and the
board therefore needs to demonstrate that it has acted independently.
(2)
The costs of taking action to counter the bad publicity that may be a
consequence of the treatment of the protestors
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3 Anne
(1)
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(i)
Obedience
As an employee Anne owes the duty of obedience to her managers,
and should comply with reasonable orders provided they do not
breach her professional duties.
As a professional accountant Anne should comply with the technical
and ethical standards established by her professional body, even if
these conflict with what she is being required to do in the workplace.
Interests of employer and profession
As an employee, Anne has a responsibility to promote the interests of
her employer. These include the commercial, fee-earning, interests,
making efforts to obtain new work and keep existing clients happy.
As a professional accountant, Anne has a responsibility to maintain the
good name of her accountancy body. This includes acting honestly and
objectively, and not allowing herself to be associated with misleading
information or a misleading report.
Obligations of employment and membership
As an employee, Anne owes a general duty to 'fit in', be part of a team
and behave in ways that are in accordance with the organisational
culture of her employer.
As a member of a professional accounting body, Anne owes the duty to
act in accordance with the norms of that body, including its stress on
professional behaviour.
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(ii)
Acting non-commercially
The main tension between the roles that Anne is experiencing is that if
she acts in accordance with professional standards, and pursues a full
explanation for the payment, she will not be acting in her employer's
commercial interests. The audit will go on longer than budgeted,
meaning that the assignment is less profitable. She also risks
upsetting the client and putting future income at risk.
Anne's own interests
There is also the issue of whether Anne should take into account her
own interests and if so how she should do this. She may feel that in
order to make her life easier as an employee of Fillmore Pierce, she
should allow the report to be signed. Against this is the possibility of
suffering disciplinary action by her professional body if she allows
the audit report to be signed, and it later turns out to be misleading.
(3)
Absolutist assumptions
Definition
Absolutist dogmatic assumptions are based on the idea that there are rules
which should be followed in all circumstances, whatever the
consequences. This means that if an individual is facing an ethical dilemma,
there should be a 'right' solution to that dilemma.
Van Buren situation
Absolutist assumptions would indicate that an audit provides
independent assurance on a business. Because of this, all material audit
queries need to be resolved if an unqualified audit report is to be given.
Conclusion using absolutist assumptions
Resolving the query is the right course of action to take and thus should be
pursued, even if it means a longer audit and problems with the client.
Relativist assumptions
Definition
A relativist position would be that there are a variety of ethical beliefs and
practices, and that the ethics that are most appropriate in a given situation
will depend on the conditions at that time. A pragmatic consequentialist
position would consider the consequences of the various options available,
and choose the option that on balance produced the greatest benefits or
the least degree of harm. This may be benefits or lack of harm in general, or
it may be defined more narrowly to mean benefits or lack of harm to
Fillmore Pierce or even just to Anne herself (which would be egoism).
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Conventional viewpoint
Kohlberg identified the conventional viewpoint as one of the levels of moral
reasoning. Using this perspective, individuals judge ethical decisions in
terms of what is expected of them in terms of the norms of society or
organisation. In this example Anne would take into account what would be
considered good practice in the industry and the relevant accounting body
and auditing rules. She would also consider society's viewpoint as expressed
in the law; would signing-off on the audit be expected of them by the law? Is
there a potential that this is fraud and therefore illegal? Another viewpoint
would be whether members of society outside of the accounting and
auditing professions would approve of signing off on the audit.
Pre-conventional viewpoint
The pre-conventional reasoning viewpoint sees reasoning in terms of the
rewards or punishments that will result from a particular act. The factors
influencing the decision would be whether Fillemore Pierce and Van Buren
Company would suffer a legal penalty through the actions/or lack of actions
Anne would take, whether Fillemore Pierce would lose business by not
signing off on the business (as Zachery indicates) or would it lose business
in the future by signing off on potential fraud?
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4 Poodle
(1)
Implications
The value of the claim is material to the group financial statements, at 25%
of group profit before tax (= $0.5m $2m).
The treatment in Toy Co's individual financial statements appears correct in
line with the local financial reporting framework. However, these financial
statements must be restated in accordance with IFRS for consolidation into
the group accounts.
According to IFRS, a provision should be recognised. This is because there is
a probable outflow of resources which can be measured reliably. The
omission of the provision means that the financial statements are materially
misstated.
Procedures
Verbal evidence is not sufficient for the group audit, and Toy Co's legal
advisors should be asked to provide a written statement that, in their
opinion, it is probable that damages will have to be paid.
As this is a material matter which could result in a qualified auditor's
opinion, further evidence surrounding the claim should be obtained. The
claim itself should therefore be reviewed, along with any board minutes
discussing the claim.
Report
The Group should be asked to adjust the group financial statements for the
claim, and it should be explained to them that if the adjustment is not made
then a qualified opinion will be expressed.
The Group's reluctance to make changes, taken together with the impending
deadline for releasing the financial statements, represents a significant
intimidation threat to the auditor's independence. This may call into
question the integrity of the management and the reliability of its written
representations.
If the financial statements are not adjusted then the auditor will express a
qualified 'except for' opinion on the grounds that the financial statements
are materially misstated.
The misstatement is not pervasive as it appears to be confined to one
specific area of the financial statements, so an adverse opinion is not
necessary.
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The auditor's report should include a paragraph headed 'Basis for Qualified
Opinion' immediately before the Opinion paragraph, in which the reasons for
the qualification are described.
(2)
Implications
The trade receivable is material to the group financial statements, at 2.8% of
total assets and 80% of profit before tax.
SLAuS 560 Subsequent Events requires the auditor to consider evidence
obtained after the year end and before the issuance of the auditor's report.
The notice constitutes evidence that the receivable is impaired at the year
end; the insolvency of Terrier is therefore an adjusting event.
The receivable is impaired by $1.44m (= $1.6 Mn 90%), which should be
recognised as follows.
Dr
Operating expenses
$1.44 Mn
Cr
Trade receivables
$1.44 Mn
Procedures
A copy of the notice from Terrier's administrators should be obtained to
confirm that the company is insolvent and that 10% of the debt will be
received.
Obtain written confirmation from the administrators regarding the expected
timing of the payment.
Bank receipts post-year end should be reviewed for evidence of the payment
being received. However, given when the notice was received and the tight
deadline for the auditor's report, it is not likely that amount will have been
received.
Report
If the financial statements are not adjusted, then the auditor's opinion will be
qualified 'except for' in relation to this issue.
Aggregate effect on financial statements
The overall effect of the provision and the impaired receivable is to reduce
net profit by $1.94 Mn, which would reduce profit before tax to just $60,000.
It could reasonably be argued that this is a pervasive misstatement, as it
affects multiple areas of the financial statements and is highly material to
profit before tax.
In this case, an adverse auditor's opinion should be expressed.
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The auditor's report should include a paragraph headed 'Basis for Adverse
Opinion' immediately before the Opinion paragraph, in which the reasons for
the adverse opinion are described.
(3)
Implications
The chairman's statement is other information, which SLAuSs require the
auditor to read. The auditor is looking for material inconsistencies with the
audited financial statements, which may undermine the credibility of the
financial statements and the auditor's report.
The chairman's claim that revenue has risen by 20% is materially
inconsistent with the financial statements, which indicate a rise of 5.9%.
Procedures
SLAuS require the auditor first to determine which of the chairman's
statement and the financial statements needs to be amended.
It will be necessary to review the audit evidence obtained on revenue to
ensure that it is sufficient and appropriate.
Explanation should be obtained from the chairman of how his figure of 20%
was arrived at, as it is possible that this will shed further light on the real
figure for revenue. If no further information comes to light and the
chairman's statement is incorrect, then he should be asked to amend it.
Report
If management refuses to amend the other information then the auditor's
report must be modified to include an Other Matter paragraph. This would
not affect the auditor's opinion, which would be unmodified in this respect
(although it may be modified in other respects, as discussed in parts (1) and
(2)).
This paragraph should be presented immediately after the opinion
paragraph, and should describe the material inconsistency clearly.
The matter should be communicated to those charged with governance. It
may be necessary for the auditor to speak at a shareholders' meeting in
order to explain the reasons for including the Other Matter paragraph in the
report.
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5 Lychee
(1)
(i)
(ii)
Reviewing board minutes for details of the plan and to verify that
it has been approved by the board
If the financial statements are not amended then they are not in
accordance with LKAS 10. Considering the materiality of the cost of
closure:
Based on revenue:
$250,000
= 1.67%
$15m
Based on profit:
$250,000
= 8.3%
$3m
Based on assets:
$250,000
= <1%
$80m
The cost of closure is material to the statement of profit or loss, so nondisclosure of this event is a material misstatement. In line with SLAuS
705 Modifications to the Opinion in the Independent Auditor's Report,
the auditor should express a qualified 'except for' opinion, as the
misstatement is material but not so pervasive as to render the
statement of profit or loss meaningless.
The auditor's report should contain a paragraph discussing the reasons
for the modified opinion, in which the auditor would explain the nature
of the costs not disclosed, state the financial effect of the costs and state
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that this is in breach of LKAS 10. It would also be helpful for the auditor
to state that this does not affect profit for the year, but is a disclosure
only.
(2)
(i)
(ii)
An Other Matter (OM) paragraph has in common with the EoM the fact
that it does not modify the auditor's opinion. However, whereas the
EoM refers to a matter within the financial statements, an OM refers to
information that is rightly not present in the financial statements, but
which is so important for users' understanding of them that it needs to
be highlighted in the auditor's report.
Examples of situations include:
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The OM is thus a means for the auditor to communicate with users, and
should state explicitly that the matter referred to is not required to be
included in the financial statements.
6 Axis & Co
(1)
Lorenze Co
The company has changed its accounting policy for goodwill during the year
and failed to disclose this in the financial statements. In accordance with
LKAS 8 Accounting policies, changes in accounting estimates and errors, the
change in policy should be disclosed in the accounts.
An unmodified opinion on the financial statements with the inclusion of an
emphasis of matter paragraph is therefore not suitable as the opinion should
be modified on the grounds of a misstatement regarding disclosure
depending on the materiality of the issue, the modification would either be
qualified ('except for') (if material) or adverse (if pervasive).
(2)
Abrupt Co
Jingle Co
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(i)
(ii)
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7 Willow
(1)
(i)
Inventory
This area is not material to net assets or to income and expenses, but
could become so in combination with any other immaterial
misstatements detected. Unless this is the case, there would be no
effect on the audit report.
LKAS 2 Inventories requires inventory to be measured at the lower of
cost and net realisable value (NRV). If the NRV is zero, then an expense
of Rs. 130,000 will be incurred, reducing both and assets by the same
amount.
SLAuS 580 Written representations states that a written representation
is not of itself sufficient appropriate audit evidence. Therefore further
evidence must be obtained.
The assertion that must be tested here is that NRV is not less than Rs.
130,000. The finance director's claim that the inventory can be
recycled would therefore need to be supported by evidence that the
NRV of this recycled inventory would not be less than Rs. 130,000.
Further procedures include:
(ii)
Reviewing invoices raised after the period end for evidence that
the materials have in fact been recycled and sold on.
Provisions
This area is not material to net assets or to income and expenses, but
could become so in combination with any other immaterial
misstatements detected.
LKAS 37 Provisions, contingent liabilities and contingent assets requires
that a provision be recognised where it is probable that there would be
an outflow of resources embodying economic benefits, as is the case
here. If this adjustment is not made then liabilities and expenses are
both understated. There is also unlikely to be adequate disclosure of
the circumstances surrounding the case.
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(2)
82
Review the written terms of the loan to confirm the interest rate
and any other conditions.
Property
A move from recognising properties at cost to at fair value would be
acceptable in line with LKAS 16 Property, plant and equipment, as long as it
is applied across an entire class of assets. The committee should be aware of
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the benefits and drawbacks of such a change. Benefits include more relevant
information on the values of properties, and quicker recognition of fair value
gains in the financial statements. But the drawbacks include the need to
remeasure fair value at each period end. It may also be necessary to employ
an external expert to estimate fair values, which could be costly.
Asset register
The delay in receiving the non-current asset register would have impaired
audit efficiency, and potentially resulted in greater audit costs and therefore
fees.
The fact that the issue was discussed with the committee last year but then
recurred, suggests some sort of controls failure; either the last year's
discussion was not acted upon by the committee, or at some other point. In
both cases the reason for this needs to be ascertained.
The fact the financial controller has been on holiday at the start of the audit
for two years running is not just unhelpful, but may be a cause for concern eg
indicative of fraudulent behaviour.
Procurement
No explanation is actually given for why invoices are not matched to goods
received notes; there is no reason why this cannot be done if suppliers are
changed frequently, for example. Without this control, it is possible that
invoices are paid without goods ever being received. There is also a risk of
fraud if this is done intentionally, either delivering goods to another address
or using dummy invoices. The committee should seek to improve controls in
this area as a matter of some urgency.
Frequently switching suppliers is not itself a problem, but again this would
not seem to totally preclude maintaining a list of approved suppliers it only
means that such a list would be a long one. If totally new suppliers really are
being used so frequently, then there may be issues with quality rather than
price.
Financial controller
There are a number of ethical issues here. First, the offer of three weeks' use
of her holiday home needs to be considered in light of the CA Sri Lanka Code
of Ethics requirements on gifts and hospitality. In this case the value of the
offer is likely to mean that no safeguards could prevent the auditors'
independence being impaired, so the offer should be declined. If the team
considers that Mia Fern intends to influence the outcome of the audit by
making the offer, then this casts doubt on her integrity. The audit committee
should be notified of this situation.
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The gifts of lunches are unlikely to impair independence as they are likely to
be of an insignificant monetary value. Provided that this is the case, they may
be accepted.
8 Colombo
(1)
Revising materiality
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If this is the case, then profit has been materially overstated, and liabilities
understated.
Property revaluation
The gain of Rs. 800,000 was just below initial materiality of Rs. 900,000, but
above the current materiality level of Rs. 700,000. Audit procedures must
now be performed in this area, as it is possible that there could be a material
misstatement here.
Actuarial loss
The actuarial losses are material, at Rs. 1.1 Mn, as is the defined benefit
liability of Rs. 10.82 Mn.
Axle Plc is a service organisation, and SLAuS 402 Audit considerations
relating to an entity using a service organisation requires the auditor to
obtain an understanding of this organisation. This can be obtained:
From the Group itself, we should gain an understanding of how Axle Plc
arrives at its valuation, its systems and its controls.
By obtaining a report from the auditor of Axle Plc (the service auditor),
which contains an opinion on the description of Axle Plc's systems and
controls.
This has not been done, and we have no information about how the plan
assets and liabilities were valued, or how reliable their valuation might be.
The audit team must therefore obtain this information before the service
organisation's representation can be relied upon.
Goodwill impairment
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The division held for sale is part of a subsidiary. Therefore, some of the
goodwill relating to this subsidiary may need to be reclassified as part of the
disposal group of assets held for sale. Although it is possible that no goodwill
will need to be reclassified, evidence needs to be obtained that this is the
case.
The statement of financial position contains one line within assets for 'assets
classified as held for sale'. This disclosure is incorrect: the assets held for
sale should be a separate section within 'assets'.
It appears that this Rs. 7.8 Mn could be a net figure, which again is incorrect
there should also be a separate section within 'liabilities' showing the
liabilities from the disposal group. Audit procedures should be performed to
ascertain whether this in fact a net figure, in order to get the classification
right.
Although there are assets held for sale from a trading division, the statement
or profit or loss shows no discontinued operations. SLFRS 5 Non-current
Assets Held for Sale and Discontinued Operations requires the post-tax profit
or loss of discontinued operations to be shown as a single line. This appears
to be a material misstatement, and audit procedures should be performed to
determine whether it is or not whether there are any discontinued
operations.
Non-controlling interest
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9 Banana
(1)
(i)
Matters to consider
Materiality
Materiality on revenue:
Rs. 500,000
= 4%
Rs. 12.5 Mn
Rs.500,000
= 125%
Rs.400,000
Rs. 500,000
= <1%
Rs. 78 Mn
If Banana does not amend its financial statements, the audit opinion
will be modified due to a material misstatement. This would probably
be an 'except for' qualification as the misstatement is material but not
pervasive.
Evidence
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Testing for completeness and that all invoices that should have been
accrued for were in fact accrued for.
(ii)
Matters to consider
Materiality for whole receivable
Materiality on revenue:
Rs. 30,000
= 2.4%
Rs. 12.5 Mn
Rs. 300,000
= 75%
Rs. 400,000
Rs. 300,000
= <1%
Rs. 78 Mn
Rs. 225,000
= 1.8%
Rs. 12.5 Mn
Rs. 225,000
= 56%
Rs. 400,000
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Audit opinion
If Banana does not amend its financial statements, the audit opinion
will be modified due to a material misstatement. This would probably
be an 'except for' qualification as the misstatement is material but not
pervasive.
If the misstatement in respect of the receivable is taken together with
the misstatement in respect of the training costs, the overall result may
be that Grape & Co judges the statement of profit or loss to be rendered
meaningless (pervasive effect). In this case it would issue an adverse
audit opinion.
Audit evidence
(2)
The fact that the junior had only worked on two audits before this is not a
problem. However, it is important that they be given work appropriate to
their level of skill and experience. This does not appear to have happened
here, as detailed below.
No audit planning meeting
The audit planning meeting, led by the partner, is a crucial part of the audit.
It is the best way of giving the team an understanding of the client, and
should discuss both the overall strategy and the detailed audit plan, perhaps
going into difficulties that have been experienced in previous years and
which could come up again. The discussion should focus on what individual
members of the team need to do. This is particularly important for less
experienced and junior members of the team.
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The manager should not have given the senior responsibility for the audit
while they were away on holiday for three weeks. It is important that an
audit is properly supervised, and it may have been more appropriate for
another manager to take responsibility for the audit.
Senior busy
Not only is there a question mark over whether they have the experience to
manage the audit, but the senior is also busy with other assignments and
thus unable to devote sufficient time to this one. It is very important that
someone is available to supervise junior members of the audit team. This is
not happening here.
It is also possible that the lack of attention paid by both the manager and the
senior has led to the misstatements in respect of the trading costs and trade
receivables not being picked up by the audit team.
Junior auditing goodwill and inventory
The junior helped the client's staff to count raw materials at the inventorytake, when they should instead have been observing that the client's staff
were counting them correctly and in accordance with the count procedures.
This would seem to imply that the junior had not been properly briefed on
their responsibilities at the inventory-take, as this is a relatively basic error.
It is likely that more audit evidence will be needed to be done on inventory
as a result of this error.
Junior asked to challenge FD
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Selecting a sample on the basis of the ease of finding evidence for an item, is
not an appropriate basis. Indeed, this might actively increase detection risk
as it means by definition that those items for which evidence is not readily
available, or might not even exist, are not tested.
Conclusion
The failures above suggests that this engagement has not been adequately
supervised, and that the audit work performed is inadequate in some areas.
A detailed review should be performed so that any other shortcomings can
be addressed.
Doubt is also cast over the sufficiency of the firm's quality control
procedures. This matter should be referred to the relevant partner for
consideration.
10 Retriever
(1)
The Group obtained a listing during the year which means that its financial
statements will be the subject of particular scrutiny. This raises the overall
risk level of this assignment, which means it should be subject to especially
stringent quality control. This does not appear to have been the case.
Engagement quality control review
The fact that there is an engagement quality control review taking place is an
encouraging sign, as it summons the prospect of some of the more egregious
failings of quality control being made good before the auditor's report is
signed.
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Time pressure
The existence of time pressure points to poor planning. The purpose of the
audit plan is not only to direct audit work to appropriate areas of the
financial statements, but also to decide on the resources and deadlines
necessary to complete the audit satisfactorily.
Time pressure increases detection risk. Procedures are likely to be rushed,
resulting in a lack of professional scepticism and misstatements going
undetected. This seems to be what has happened here.
Directors' emoluments
The audit manager described these as low risk, but they are material by
nature. Not only are they related party transactions, they carry a high risk of
manipulation as directors may attempt to conceal their remuneration from
shareholders and other users of the financial statements.
There will also be additional reporting requirements as this is a listed group,
which only increases the risk to the auditor.
Even if they were low risk, planned audit procedures would still need to be
performed. The fact they are high risk only heightens this necessity.
Share capital
If the group were not listed, then share capital might be low risk. However,
the fact it obtained a listing during the year means that share capital could
have changed significantly. This is a highly visible area, and is therefore high
risk.
Sampling method
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It may well be good training for juniors to review each other's work, but this
is no substitute for proper supervision and monitoring by more senior
members of the audit team. Being at the same level, juniors are unlikely to be
able to spot any errors or invalid conclusions drawn, so the reviews are
likely to be of little use. Moreover, the juniors are likely to be very familiar
with each other and may be unwilling to criticise each other's work. The
work should have been reviewed by the audit manager.
Financial controller
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The junior should not have been discussing the tax position with the
financial controller in the first place. Given that the time on the audit is so
short, what time there is would be better allocated to performing audit
procedures. This points to a lack of supervision, and also to a need for
further training for the audit junior.
Deferred tax asset
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(2)
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From the circumstances described it is possible that the thieves may have
been Group employees. This information should be obtained from
management.
Finally, the output of the investigation should be confirmed. The Group may
require a report to the insurance company for example, or alternatively a
report addressed to itself but which it can use for the purposes of the
insurance claim. It should be clarified that the report would not be
distributable to any other parties.
(3)
Procedures
Discuss the case with police to establish if any goods have been
recovered and if this is likely to happen.
Obtain details of stolen lorry, eg licence plate, and agree the lorry to
non-current asset register.
11 Dragon Group
(1)
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likely to be used on the audit, along with estimates of the amount of time the
audit would be likely to take.
Dragon Group's needs and how Unicorn & Co could meet them
(i)
An explanation of the need for each subsidiary (as well as Dragon Plc)
to have its own individual audit, and for the consolidated financial
statements then to be audited too.
That Unicorn & Co is a large firm and would be capable of auditing a
large group such as this.
(ii)
The Dragon Group may also need some non-audit services (see below).
That Unicorn & Co can provide a variety of non-audit services, should
they be required.
A description of any other services Unicorn & Co can offer, such as offering
advice in relation to the proposed stock exchange listing. Careful
consideration should be given to ethical requirements relating to
independence when offering other services to a potential audit client.
Key staff
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This is a large, transnational group, carrying a high level of risk. Unicorn &
Co should take on the audit only once it is sure that it is able to do so, and is
assured of a fee that adequately compensates it for the level of risk involved
in undertaking the audit.
(2)
The Dragon Group is large and expanding group of companies, and would
therefore require a high level of resources to audit. Unicorn & Co must
consider whether it has sufficient staff available to audit a growing group of
this size.
Overseas subsidiaries
Half of the subsidiaries are located overseas. Unicorn & Co has a large
number of overseas offices which could perform some or all of the overseas
audits. However, these offices may not all have specialist retail audit
departments, so consideration needs to be given to whether there is enough
experienced staff to carry out the audit.
If some of the overseas audit work needs to be done by auditors outside of
Unicorn & Co, then this work would need to be evaluated in order to express
an opinion on the group financial statements.
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Relevant expertise
The group's year end is 30 September 20X9, and management wants the audit
completed by 31 December 20X9. This represents a tight deadline, given that
the audit involves a large number of subsidiaries located in several different
countries and reporting under a number of different accounting rules. The
fact that this would be the first year that Unicorn & Co would have audited
the group also makes the deadline tight. There is also a possibility that
management do not fully understand what is required for an audit.
Planned listing
Unicorn & Co should consider the reason for the group seeking to change its
auditor, as this might affect the decision to accept the engagement. On the
face of it, it appears likely that the quickly-growing group has outgrown its
previous auditors, but Unicorn & Co should still seek to obtain the reason for
the change from the previous auditors.
Mermaid Pvt Ltd
Minotaur Plc operates in a different business area from the rest of the group,
so Unicorn & Co must consider whether it has staff available with the
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There are a number of possible threats to Unicorn & Co's independence here:
Self-interest: Kia may have an interest in not causing problems for her
relative, and may be unwilling to challenge them if required to do so.
To assess the severity of the threat, the degree of influence held by the family
member and by Kia must be considered. As financial controller and audit
senior respectively, both would have some influence over the financial
statements. It would therefore be unlikely that Kia would be able to be
assigned to this audit engagement.
Furthermore, allocation of staff to audit teams should be the decision of
Unicorn & Co alone. Staff should be allocated on the basis of their experience
and skills. There is a risk of the audit team possessing an inappropriate mix
of experience and skills for this audit if Unicorn & Co were not able to select
the audit team, which may impair audit quality. It is therefore crucial that
Unicorn & Co exercise a free choice over the composition of the audit team.
12 Lapwing
(1)
It should be confirmed that the report will be provided to the bank, as this
may establish Lapwing & Co as potentially liable to the bank.
Distribution of report
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forecast financial statements included in it. This will affect the extent of
Lapwing & Co's possible liability, and the extent of procedures required.
Nature of assumptions
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Operating margin rises from 30% to 33.8%. Ask for explanation from
management and consider if reasonable.
Discuss sale of Beak Retail, including likelihood of sale and any likely
terms. Review board minutes for details about the sale.
102
Non-current assets are up Rs. 37.15 Mn, but the loan which financed
this investment was only for Rs. 30 Mn. Enquire about other possible
sources of finance used for this increase.
Confirm that any assets relating to the joint venture with Kestrel are
accounted for in line with SLFRS 11 Joint arrangements.
Discuss the planned Rs. 5 Mn increase in equity (is this to help finance
the increase in assets?). Discuss what form this will take (ie rights
issue, or at full market price).
Payables days are predicted to fall from 137 days (5,400 / 14,420
365) to 124 days (5,600 / 16,550 365), worsening the company's
cash position. The reasons for this should be discussed with
management, and considered for reasonableness.
Answers
(3)
Discuss the deferred tax provision, and establish why there has been
no movement (which is unexpected, given the capital expenditure).
Ethical issues
The key issue with the provision of other services is that independence of
the auditor may be impaired as a result. In principle, CA Sri Lanka Code does
not prohibit the provision of other services. However, the fundamental
principles apply to all professional assignments. Therefore the audit firm
must assess the threats to which it is exposed in performing the engagement
and consider whether safeguards are necessary. In this instance appropriate
courses of action would include:
13 Baltimore
(1)
Equity owners
It is noted that Vic and Lou secured funds from Bizgrow. The nature of any
agreement that was made needs to be ascertained, as it is possible that
Mizzen may owe Bizgrow a substantial amount of money. This would be
material to any decision Baltimore might make about the acquisition.
The precise nature of the ongoing relationship between Mizzen and Bizgrow
is unclear. It is possible that Bizgrow is involved with Mizzen at an
operational level. Any agreements between the two parties should be
obtained and scrutinised.
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Mizzen's good reputation, and its having won awards for website design, is
key evidence for its expertise in this area. This should be verified to external
evidence. Customer satisfaction could be gauged by obtaining the results of
any customer satisfaction surveys that may have been conducted.
Vic and Lou
Mizzen is a business with few tangible assets, which relies heavily on the
expertise of its employees, who may leave after any acquisition particularly
if Vic and Lou were to leave. It would make little sense to acquire Mizzen for
its staff, only to find that they leave on acquisition.
An organisational structure should be obtained in order to identify
management and key personnel within Mizzen.
It is also possible that Baltimore may wish to restructure Mizzen after
acquisition. In this case it is likely that redundancy payments would need to
be made to staff members losing their jobs. The amount of any possible
liability in this eventuality should be estimated as part of the review.
Freelancers
Mizzen has been using freelancers recently, which may result in a drop in the
quality of work done by comparison with established staff. This should be
investigated as it may affect Mizzen's ostensibly impeccable reputation.
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Intangible assets
Mizzen has few assets, but is likely to have important intangible assets which
would form part of any goodwill paid on acquisition. Vic and Lou have
developed new website interfaces, and it should be determined whether any
resulting intellectual property belongs to them personally or to Mizzen.
Valuing these assets is likely to be difficult.
Customer databases should also be valued, which again is likely to be
difficult owing to the absence of any active market for assets of this kind.
Premises
It is apparent that the Rs. 1,000 nominal rent paid to Bizgrow would increase
after the acquisition, so it should be determined what an equivalent market
rent might be for the premises. Alternatively, the premises may no longer be
available, in which case the rent should be ascertained for premises meeting
Mizzen's needs. It may be possible for Mizzen to operate from Baltimore's
premises, in which case any opportunity costs should be considered.
Tangible assets
The first revenue stream should be split into two components, with the
revenue relating to maintenance being recognised as deferred income and
spread over the contract period. There is a risk that revenue is recognised
too early, inflating Mizzen's profit in the short term.
Relevance of revenue
Baltimore needs Mizzen to develop a website for it, and it should be asked
whether Baltimore might be better off simply paying Mizzen Rs. 10,000 to
develop a website rather than acquiring the whole company.
It is clear that Mizzen would have the expertise to do this because it operates
its own subscription-based website. It should therefore be able to create
something of a similar nature for Baltimore.
The third revenue stream in particular does not appear relevant to
Baltimore, and it should be considered how this revenue stream would be
managed after the acquisition.
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Revenue increase
Operating expenses in 20X2 were 58.3% of revenue, but only 49.6% in 20X3.
This is unusual, and may be indicative of efficiencies being achieved as
Mizzen grows. It does not, however, tally with the fact that freelancers have
been used this year, which would be expected to increase operating
expenses in relation to revenue.
A detailed review needs to be performed on operating expenses to ensure
that expenses are complete and are recorded accurately.
Cash
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Copy of any agreement between Bizgrow and Vic and Lou, to help
understand their ongoing relationship as well as Bizgrow's planned
exit route.
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(2)
Details of any dividend payments made over the last three years.
Due diligence can be a review engagement, and as such provides only limited
assurance. Some due diligence can be undertaken as an agreed-upon
procedures engagement in which case no assurance is provided only
factual findings are reported. By contrast an external auditor's report gives
reasonable assurance, which is a higher level of assurance. This is because
review engagements and agreed-upon procedures engagements involve
obtaining less evidence than is required for an external auditor's report, and
conducting procedures which are less thorough.
The conclusion of a review report is expressed negatively, and would begin
with the wording, 'Based on our review, nothing has come to our attention...'.
In an agreed-upon procedures report, there would be a statement that the
procedures performed do not constitute either an audit or a review and so
no assurance is expressed.
The conclusion of an external auditor's report is phrased positively, and may
state that the financial statements do in fact 'present fairly', or 'give a true
and fair view of', the entity's financial position, performance and cash flows.
(3)
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Goleen & Co would need to carry out market research to ensure that there is
a demand for recruitment services before embarking on any new business
venture.
Training costs
The firm should also consider whether it has the time and resources to enter
into a new area of business. Ingrid Sharapova only worked in recruitment for
a year and seems to be the only employee with any experience. She may
require further training in order to recruit finance professionals and update
her skills.
An additional member of staff at Goleen & Co will also require some training
so the recruitment business can be kept running whilst Ingrid is away or on
sick leave.
If successful, the recruitment business may prove too much for Ingrid to
handle alone and the firm will have to either train or hire additional staff to
assist her.
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Damage to reputation
14 Apricot
(1)
General procedures
(i)
(ii)
Check that the opening cash balance agrees to bank reconciliations and
statements.
(iii) Enquire as to who prepared the forecast, and verify that they are
competent to do so (evidence eg by being a chartered certified
accountant).
Operating cash receipts
(i)
Enquire as to the basis for the forecast rise in both cash and credit sales
receipts.
(ii)
(iii) Confirm split between cash and credit sales to past trends and to
knowledge of the business.
(iv) Recalculate cash receipts from credit sales from revenue figures in
profit forecast and ageing structure of receivables.
(v)
Verify that the 10% discount for cash payment has been taken into
account when calculating cash received from cash sales.
(vi) Enquire as to who Apricot's major customers are and confirm that they
are to continue trading with Apricot, eg that none are going into
administration.
Operating cash payments
(i)
(ii)
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(iv) Verify the accuracy of the statement that suppliers are paid within 30
days by reviewing aged payables analyses for historical information.
(v)
(i)
Agree the cost of the licence to supporting information from the health
and safety authority, and confirm the cost of Rs. 35,000.
(ii)
(ii)
(iii) A reference to the purpose of the PFI, which in this case is to provide
assurance to Pik Choi's financial advisor regarding Apricots cash flow
forecast
(iv) A statement of negative assurance as to whether the assumptions
provide a reasonable basis for the prospective financial information
(v)
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A report on PFI can only provide negative assurance because of its subjective
nature as it is based on assumptions of future results.
To determine whether the firm is liable, the criteria generally applied are
that the firm is liable to persons with whom there is proximity only or whose
relationship approaches privity and to persons of a limited group for whose
benefit the information was supplied or who knew that the recipient was
going to receive the information and to persons who can reasonably be
foreseen to rely on the information.
To reduce the liability, the accountant must ensure that the report contains
sufficient caveats as to the achievability of the forecasts. The report should
also refer to the fact that the engagement was undertaken in accordance
with SLSAE 3400 The examination of prospective financial information (or
relevant national standards or practices applicable to the examination of
PFI).
The report should include a statement that it is the management who is
responsible for the prospective financial information, including the
assumptions on which it is based, not the assurance firm.
Another important point to include is that the information is for restricted
use, so it should include who it has been prepared for and who is entitled to
rely on it. Reference should also be made to the fact that the engagement to
review the PFI was undertaken in accordance with the terms of the
engagement.
The terms of the engagement should include an appropriate liability cap. In
some cases, it may be possible to obtain indemnity from the client in respect
of claims from third parties.
(4)
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the threat to an acceptable level, then it can go ahead with both the audit and
the valuation service. Safeguards may include:
Using separate personnel for the valuation service and the audit
Confirming that the client understands the valuation method and the
assumptions used
15 Beech
(1)
Fir Plc
Matters to consider
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The note to the financial statements does not conform to LKAS 37's
requirement to provide narrative information, including disclosure of the
reasons for making the provision together with any uncertainties in relation
to them. The notes should also analyse the movement in the year. Unless this
is remedied then this is a material misstatement which may lead to a
qualified audit opinion.
Audit evidence
(2)
Spruce Plc
The expert should have been provided with clear written instructions
covering the objectives of the work and any specific issues to address. The
first procedure would therefore be assessing whether the work done meets
these objectives, whether it has been performed in accordance with any
standards specified, and that it is consistent with the applicable financial
reporting framework.
The expert's work should be reviewed to confirm that the correct source
data was used, and that it relates to the right financial instruments in the
right period. Any assumptions made by the expert should be compared with
eg similar assumptions used by management in preparing the financial
statements.
Any evidence contained in the report should be reviewed for consistency
with our understanding of the entity and with other audit evidence obtained.
Evidence used by the expert should be agreed to supporting documentation,
and any calculations contained in the work should be reperformed, eg fair
value movements.
The appropriateness of any models used by the expert should be evaluated.
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(3)
Pine Plc
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16 Seatown
(1)
Economy
Costs of labour
Similar comparisons for labour costs should be made for machinery costs
such as vehicle running costs. The analysis made will need to take into
account the cost drivers such as the number of tractors and the number of
vehicle miles covered.
As well as management accounting cost information and budgets,
details of vehicle miles covered will also need to be maintained.
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Efficiency
Efficient use of labour and machines
The council needs to find out how resources are being used. It needs to know
how much time is being spent sweeping the sands and how frequently
bins are being emptied. The actual frequency of emptying bins should be
compared with the standards the council set, to review whether bins are
being emptied more frequently than required or whether the schedule for
emptying bins is unrealistic.
It would also be helpful to have more detail about how much time is being
spent on different areas. Some beaches may be more problematic to clean
because of obstacles such as rocks. The time and costs spent on these
beaches could be reduced by limiting access to them to popular times of the
year. To judge efficiency fairly though, the council will also need to take into
account the area of different beaches and the number of litter bins.
Employees will need to maintain detailed records of the time spent on
each beach and when they empty the litter bins. It will also be important
to keep the permanent data, the areas covered by cleaning and the number
of litter bins, up-to-date.
(2)
The council will need to ascertain how much refuse has been collected. Again
it will be helpful if the refuse collected from sweeping can be recorded
separately from the refuse collected from bins, in order to judge both
activities fairly. When quantities are reviewed over time, it will be useful to
see how much the litter generated is proportionate to the number of
visitors. The Council should also try to identify whether other seasonal
variations have a significant influence (visitors being less likely to
consume food and hence drop food litter during the autumn and winter, and
also fewer refreshment kiosks being open during these seasons). The council
will need to assess whether more staff resources are needed at the busiest
times of the year to keep the litter under control.
Records kept will therefore need to include the quantity of litter disposed of
each week. There are various ways in which the number of visitors can be
estimated, including number of users of tourist information centres, car
park records and estimates based on physical space occupied by each
beach user.
Quantity of refuse not collected
As well as assessing how much litter has been collected, the council needs to
have an idea of whether all litter has been collected from the beach (or
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17 WWW
(1)
Situation 1
Integrity This situation could be in conflict with the fundamental principle
of integrity.
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WWWs profit for 20X3 if it were successful, the CEO did not mention the
claim in his presentation to the analysts and journalists. This omission is
therefore misleading, because it prevents his audience from being aware
that WWWs profit for 20X3 might be materially lower than the figure given
in the forecast.
Tutorial Note:
This is the case in Situation 2. WWW has been required to produce the
documents as a result of the court order obtained by the Government.
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Advice:
By contrast, the financial controller does not appear to have considered the
profitability of the joint venture, or the commercial benefits to WWW of
continuing with it.
Conflict - In this respect, it appears that financial controllers decision has
been biased as a result of the problems which he and his staff have
encountered in working with ZZZ.
Advice:
This situation represents a conflict with the Code, and specifically with the
principle of objectivity.
(2)
WWW could use the following stages for resolving ethical conflicts:
Establish the all relevant facts and information
Identify the ethical issues which are involved, and identify the
fundamental ethical principles related to the matter in question. These
principles should be identified in WWWs published Code of Ethics, but
alternatively WWW could refer to a Code published by a professional body
such as CASL or IFAC (in its Code of Ethics).
Follow procedures Where possible, WWW should follow its internal
procedures when enquiring into the ethical conflict.
Identify potential courses of action WWW should investigate possible
courses of action which it could use to resolve the conflict, and should
consider the potential consequences of each possible course of action.
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18 VV
(1)
(i)
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Section 2
1 Daily Newspapers
(1)
(i)
Reliability
Dailys reputation for producing reliable news may be threatened by
allowing subscribers to post on its site. What subscribers post will
not be subject to the same checks that a story in Dailys newspapers
would be subject. Subscribers may be more inclined to post doubtful
material on Dailys website than on personal blogs, because of the
wider readership it will have. If what is posted is untrue, Daily will
suffer by association, particularly if it is publicly known that Daily does
not carry out checks on the contents of its site. This may affect not just
the reputation of the Sunday newspaper, but all publications within
Dailys group.
Values
The brand values Daily promotes of quality reporting and information
may be undermined by comments on the website that some find
offensive, even though the comments are legal. Comments may not be
of high quality. The views may be based on dubious sources of evidence
or they may be badly written. However there are upsides to allowing
controversial comments to be posted. Some newspapers promote their
comment facility as encouraging free speech with views that do not
reflect the position of the papers being allowed.
Libel
Daily may be subject to the risk of damages for libel. Daily may become
liable once the post is made on the site. As posts are not validated in
advance, in theory subscribers could post very serious libels. Daily will
remain liable even if it subsequently removes the post, although this
may mitigate damages. Those libelled are more likely to sue Daily
rather than the person who posted the libel, because they will reckon
that Daily has greater financial resources. They may also be more
inclined to sue Daily in order to deter Daily from publicising further
libels.
Advertising and readership
Some advertisers may not be willing to associate with a site with
doubtful material. Some readers may stop accessing it if they find
the content offensive. Equally, however, if Dailys site is known to
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(i)
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that risk management is being taken seriously from the board level
down to the newsroom floor.
Stifling of initiative
Auditor visits together with tougher attitudes from management may
result in expenditure being reduced. However the system could
become too bureaucratic. If rules about approving expenditure in
advance are enforced and policed by internal auditors, opportunities
may be lost if approval cannot be obtained quickly. Staff may become
fearful of incurring expenditure which may later be challenged and
therefore miss the chance to pursue a good story.
Auditor judgements
Internal auditors may find it difficult to make judgements about what
expenditure is unacceptable or doubtful, because of lack of effective
guidelines and limitations on the evidence. The expense claims they
review, for example, may show that a claim for meals in an expensive
restaurant is supported by valid documentation (that the journalist and
contact did go there) but not why that restaurant was chosen (whether
it was valid for the journalist to incur that expenditure). Auditors may
also have problems judging whether the explanation given for certain
expenditure justifies its level. For example, buying the latest
equipment may make journalists more efficient but does it justify the
amount of expenditure made?
Diversion away from other activities
Although the increase in expenses is legitimately a matter of concern,
Daily may be facing more significant risks in other areas. If internal
audit resources are limited, auditors may spend too much time on
expenses and not enough on other areas. Possibly a one-off drive to
bring journalists expenses under control may result in a reduction to
more acceptable levels and mean that there is less need for regular
internal auditor review.
(iii) Confusion over standards
Journalists may have been unclear as to what expenses they could
claim. The policies that are in place have never been effectively
enforced. Instead if journalists expense claims have always been
allowed, they may have assumed that in practice it will be fine to incur
whatever expenses are necessary to obtain a good story and
management will ignore any questionable expenses. Possibly also they
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Switch to UK supplier
Costs
Costs of raw materials
The paper may be more expensive that it would be if Daily continued to use
its current supplier, who is relatively cheap. As, however, there are three or
four suppliers in competition for Dailys business, Daily may be able to
negotiate a good deal.
Pricing of deal
The fixed price deal will however have an additional cost element built into
it. The supplier will be aware that it will be bearing risks of adverse price
movements and not be able to pass these on to Daily for the period of the
deal. The pricing will therefore include a premium to compensate the
supplier for this risk.
Risks
Exchange risk
Dealing with a HK supplier removes an element of exchange risk for Daily.
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2 Farama 1
(1)
(i)
Risks
The main risks F faces relate to its revenues, its costs, its
environmental performance and its reputation.
Set goals
The board has made the investment in order to enhance Fs social
responsibility performance. A clear upside risk is that the factory will
reduce Fs use of air travel. F needs to implement new measures, as the
steps it has taken so far were insufficient to meet its targets in 20X0.
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Publicity strategy
F needs to implement a clear publicity strategy that explains clearly its
CSR objectives. F should stress publicly that the reasons for
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Governance
F needs to obtain evidence that colleges management is committed to
supporting and promoting the courses. This includes a strategy of
publicising the courses and a guarantee that courses will not be cancelled
because of low numbers and other reasons.
F also needs to establish what arrangements management has in place for
monitoring the quality of courses. This includes review of tutor teaching
and of the quality of courses notes and support facilities. The colleges
should seek feedback from students, as well as responding appropriately to
feedback from F itself.
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Staffing
F should obtain evidence from colleges that they will be using tutors with
relevant qualifications and experience in the subjects in the programme.
The tutors should be undertaking continuous professional education.
F should establish what contingency arrangements colleges have if staff go
absent or leave suddenly.
F should also confirm with colleges what the staff-student ratio will be on
courses and also how much teaching staff are expected to do. F would want
to ensure that staff have sufficient contact and support time with
students.
Support facilities
F should find out what colleges have in terms of libraries and IT facilities. F
should assess whether these are adequate to support the planned course
programme.
F should ascertain whether libraries have purchased up-to-date copies of
textbooks, and whether colleges plan to upgrade IT facilities.
Course content
The syllabus needs to be clearly defined by the college and publicised to
students. The syllabus should include clear learning objectives that are
related to the requirements that F has. This should be supported by a
detailed learning guide that enables students to understand what they are
expected to know. The course material that students are given should be
clearly linked to the syllabus.
The exams students sit during the course should fairly and appropriately
test the knowledge and skills that students have. Fs staff should be involved
in the oversight of the exams. The quality of exams should be verified by
independent external examiners, who should be academics also with
industry experience that is relevant for Fs needs.
Placements at the factory or a sandwich structure should be built into the
course design for all students, to enable them to experience the practical
application of what they are studying. This would also enable F to assess
whether students have sufficient knowledge and application skills, and
feedback shortcomings to the colleges.
(3)
Resource planning
The development of the new system needs to be timetabled carefully, with
deadlines that match Fs requirements as the factory opens. Delays and
consequent problems with inventory management could be expensive.
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F will also need to ensure that staff with sufficient IT expertise are used to
design the systems, write the software, and be involved in the testing
process.
Analysis
F should ensure that the new system is based on an analysis of the
information F will need in the future, taking into account the views of
management, the accounts team and operational staff. The analysis should
include assessment of the training and documentation that will be required
for the new system.
The analysis should also take into account the problems F has had with its
inventory control and information technology. As well as being influenced by
the new requirements, will the systems changes attempt to remedy the other
current problems with inventory management?
Design and specification
The system design will need to specify the inputs and outputs required for
the system and incorporate the new basis for inventory management. It will
need to make clear what changes are needed from the old system.
Management and internal audit should review and sign off the specification,
confirming in particular whether it appears to meet the enhanced
information needs of the business.
Testing
The new system should be tested by IT staff and also operational
management and staff based both in Farama and in Africa. These tests need
to obtain evidence that the system will be a sufficient basis for the new
approach to inventory management.
Internal audit should also be involved in the testing process. Internal
auditors should assess whether the system can generate a sufficient audit
trail for their needs. They should also review the results of other tests, and
whether the development process has taken into account problems found.
A training programme for all sales and logistics staff that have to use the
system should be timetabled for before the system is implemented. This is
likely to involve Head Office IT staff having to go out to Africa for a period to
train local staff.
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Implementation
A direct changeover to the new system would be risky for F given its
previous IT problems, but may be the only practical solution. Parallel
running of the old and revised system would be difficult because the two
systems do not completely match.
F should conduct a post-implementation review, focusing on the number
of errors found and whether managers and staff find the information the
revised system produces to be for sufficient for their needs. This review may
form the basis of a more limited subsequent update of the system.
(4)
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Foreign loan
Currency risks
Exchange risks and interest rate
If the currency of the West African country strengthens against the F$, the
interest payments in that currency will become more expensive, as well as
the operating expenses (discussed above).
Translation risk
The loan from the government will have to be translated in Fs annual
accounts at the year-end exchange rate. However the cost of the factory will
be translated at the exchange rate on the date of the expenditure on the
factory. If the currency of the West African country strengthens against the ,
the cost of the factory will no longer be fully offset against the loan. There
will be a translation loss shown in the accounts, which may concern
shareholders.
Non-currency risks
Change in loan terms
A change in government or a change in the policy of the current government
may result in higher interest costs if the government can charge interest at
a floating rate. However the risk of this happening may be limited if the
government feels that it would threaten Fs servicing of the loan.
Collateral
The pledging of the factory in Africa is unlikely to concern Farama
lenders. Therefore F will face a low risk that its Farama borrowing
opportunities will be limited by pledging the factory to the government.
Appropriation of factory
The risk of appropriation of the factory by the current or a future
government may be decreased by the loan that F has with the government.
Appropriation would put the repayment of the loan in jeopardy. The
government may also be less likely to misappropriate the factory if it
threatens local jobs and the local economy.
Interference by government
Again F may only face a low risk of excessive government intervention in
other ways (through burdensome regulation) if the government fears it will
mean F pulling out of the country and the loan being jeopardised.
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3 Farama 2
(1)
(i)
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succeed. The risk may also be limited if those who suffered ill-health do
not have the financial resources to bring a civil action.
Impact
If F settles with claimants before the case comes to court, it could suffer
bad publicity for having acknowledged liability for poor practices. If
legal action does come to court however, the threat to reputation
may be longer-lasting. Press coverage may keep the story fresh in the
minds of the public. Even if F is cleared, evidence in the court case
could still damage its reputation.
Loss of sales
Likelihood
As well as affecting sales of the two products, F may suffer a threat to
sales of any of other products, even if there is no evidence that they
could threaten customers health. The likelihood of this occurring may
depend on the attachment the public has to other products and
whether they can easily be substituted.
Impact
The impact on sales is potentially large, as it may affect any of Fs
products. The public is unlikely to be concerned about which division
of F manufactured the products.
(ii)
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Legal defence
If F uses the legal argument that it complies with all relevant hygiene
regulations, this may not impress the public. Many of the public may
believe that F should be concerned with taking effective action to
prevent any threat to health and going beyond hygiene regulations if
necessary.
Conclusion
This argument is not suitable, as it is unlikely to remove public fears
about this type of product.
Negligence by charity
Public fears
A common problem with the other defence is that this argument
further reinforces in consumers minds the harmful nature of the
bacteria.
Passing the blame
Trying to shift the blame onto any user may be counter-productive
for F. Some of the public may take the view that F should not be selling
products containing these bacteria, particularly as many of the
products sold are ultimately for elderly people who are particularly
vulnerable to this bacterium.
Appeal of charity
The damage to reputation may be further enhanced by Fs attempts to
blame the charity. Many of the public are likely to contrast the good
work the charity is doing with Fs aim of maximising profits. They
may believe the charity must be innocent or believe that F should have
liaised more closely with the charity. The public may also dislike F
mounting a publicity campaign against charity workers who cannot
defend themselves.
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Inaccurate instructions
As with the other possible defence, the argument is undermined by the
investigation into inaccurate labelling by F and the belief that the
information it supplies is unreliable.
Conclusion
F may suffer additional damage to its reputation if it uses this
argument and therefore it, too, is unsuitable.
(2)
(i)
(ii)
Security of tenure
Recording of recipe
The recipe could be held in a secure location and brought out only if
there was no-one left who knew the recipe. This would mean that F had
a fall-back copy to which it could refer. It would also mean that the
recipe did not otherwise need to be written down and become more
vulnerable to theft as a result.
Non-disclosure agreement
The two individuals who know the recipe could be asked to sign a nondisclosure agreement. Although this would not guarantee stopping
them leaking the recipe, knowledge that there might be legal
consequences might be a deterrent.
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Staff issues
One way to stop those who know the recipe leaking it to a rival
company is to ensure that they are content working for F by
rewarding them well. The board therefore needs to monitor the
behaviour of those who know the recipe carefully and investigate any
indications that they are unhappy. Employment legislation means that
F cannot prohibit, for more than a few months, directors or staff joining
a rival company.
(3)
(i)
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(ii)
(4)
Exchange risks
Arguments against hedging
Diversification
F is well-diversified in terms of the countries it uses for supplies and hence
the currencies in which it deals. Currency movements against many
currencies may be more likely to even themselves out. Because many of
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the supplies that F uses come from a number of countries, F could possibly
change its countries of supply as a result of currency movements, although
this could mean F is not able to establish long-term relationships with
suppliers. It may also impact on the quality of supplies, which is one of Fs
major strategic concerns. Changing suppliers may also impact on other
objectives, for example the CSR objective of reduction of air travel.
Costs
The cost of derivatives to manage specific transaction risks may be high. If F
used derivatives regularly, it would probably have to employ costly treasury
expertise. Use of derivatives would mean that F could not take advantage of
favourable currency movements.
Arguments in favour of hedging
Certainty of cash flows
Use of derivatives to manage the risks relating to large transactions with
suppliers would mean that the cash flows for F would be guaranteed. This
would mean budgeting would be more predictable and pricing decisions
would not have to allow for variations in cost.
Competitor reaction
F has assumed that its competitors will react in the same way as it does to
managing currency risk. Its competitors may however take better decisions
when changing their supply policies in the light of currency movements.
Competitors may also be prepared to absorb larger fluctuations in
exchange rates than F before putting prices up. If F increases prices before
its competitors do, it may suffer unpredictable falls in demand as a result.
Price taker
F may in any case not be allowed to pass on currency movements in the
form of price rises. Significant customers, such as large supermarkets, may
be able to insist that F keeps its prices down.
Conclusion
Because of the tight margins under which F operates, the certainty of cash
flows that derivatives on large transactions offer may mean their costs are
acceptable. If F continues not to hedge, the board needs to ensure that F has
a flexible supplier management policy and an effective strategy for
responding to competition.
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4 Aybe 1
(1)
(i)
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Threats to profitability
SPDs finance department should review Qs accounts and other
evidence of its financial status. It should consider how dependent Qs
future profitability is on the success of this new car, or whether it is
very committed to any other makes. SPD should also try to assess Qs
plans for promoting the car, and whether they are likely to be
successful, particularly as it is an expensive car being marketed at a
time of financial stringency. The contract with Q should include
provisions for Q to pay financial penalties if it terminates the contract
prematurely without good reason or fails to order a certain number of
boards each year. SPD should also plan the staffing of the contract
carefully, focusing particularly on the use of technician time, and trying
to use lower grade staff for basic tasks wherever possible.
(2)
(i)
Selection
Important projects
Any projects above a certain size or which involve particularly high
risks should be audited, because of the potential magnitude of the
consequences if they do go wrong.
Projects that had problems
Projects which have failed to deliver expected benefits, have cost
too much or used too many resources should be selected for
investigation. Here obviously not only the factory building project
would be selected, but the other projects where managers had
overspent and ignored the budgets should be reviewed. If problems are
identified during the course of the project, a post-completion audit
could take place before the project ends, and the feedback result in the
rest of the project being carried out more efficiently.
Projects providing lessons
Internal audit should focus on projects that are likely to recur in future,
to see if they can be done more efficiently next time. Internal audit
should also examine projects which provide indications of how
important aspects of control systems are functioning. With Aybe,
where budgets have been ignored, internal audit should consider how
realistic the budgets were and whether improvements need to be
made to the budget-setting process.
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Performance management
The chief executives comments are surprising, since they appear to
suggest that management do not have confidence in the way their
performance is appraised generally, which is an issue that the chief
executive should be addressing. Managers should only be judged on
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factors that they can control. However the way they manage risks
should also be part of the appraisal process. It is true that managers
may be accountable for projects that they agreed should proceed but
which turned out to be unprofitable. However the appraisal process
should also identify an unduly cautious approach to risk management,
resulting in a failure to invest in projects that would have been
worthwhile.
Decisions about investment
A further problem with the chief executives comments is that they
imply that responsibility for proposing projects solely rests with
lower management. Corporate governance best practice suggests that
the board should consider major investments itself. Managers
would therefore sometimes be required to proceed on significant
projects selected by the board that might be subject to an audit.
Fairness of audit process
However the auditors are responsible for reassuring managers that
they will be judged fairly. They should obtain feedback from
managers as part of the audit process, although they should assess
managers comments objectively. Auditors conclusions and
recommendations should not be stated in unduly negative terms.
Managers should be given a fair chance to respond to the auditors
findings.
5 Aybe 2
(1)
(i)
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(ii)
To this end, it has made changes to the way its products and
services are offered and has decided to invest in a new overseas
market by establishing a joint venture in an African country
which is offering products within that and neighbouring
countries. This increases risk for Aybe since it currently has no
operations in Africa and does not sell its products to customers
based here. There is therefore no knowledge of trade within
Africa nor of other factors such as the economy, legislation and
regulation and indeed the cultural factors, all of which may be
complex.
Product risks
Possibly the most significant threat to the joint ventures existence is
that its operations are not viable. It appears to have been established
on the basis of sales forecasts that are now appearing to be overoptimistic. Costs have been increased by the failure to predict
demand correctly and hence the need to store excess inventory. If
the joint venture is unviable, it may be difficult to know when to take a
decision to cease operating, and there may be significant termination
costs.
Risks of joint venture partner
Another serious threat to the joint venture's continued existence is
Aybe falling out with its joint venture partner and the agreement
being dissolved. The joint venture would have to cease operations.
Possible causes of disagreement include pricing policy. The partner
may wish to offer discounts to establish a presence in local markets,
even though the joint venture's sales staff wish to maintain prices. It
may be difficult to assess the likelihood of these disagreements when
the contract is signed, as the position on these issues may only become
clear once the joint venture experiences trading difficulties.
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Political risks
The joint venture is also vulnerable to other changes in government
policy. The government may introduce tariffs, tighten exchange
control regulations or restrict payments for supplies as well as
limiting profit remittances, on the grounds that companies are not
charging their joint ventures a fair market rate. It may insist that the
joint venture has to use local suppliers or be managed by local
managers. Although information should be available about the
direction of the policy of the existing government, political risks and
uncertainties could increase if there is a change of government.
Economic risks
The joint venture could be affected by the risks associated with
inflation, including economic instability and a weakening of the local
exchange rate. Government action to combat inflation may also impact
seriously on the joint venture. Rises in interest rates could reduce
expenditure and increases in tax could reduce profits that can be
remitted.
Legal and reputation risks
The joint venture may face legal action and a risk to its reputation if
staff do not recycle components in accordance with stated policy but
throw them away. This risk may be enhanced if the joint venture's
staff are not experienced in handling toxic material. This may result
in costly sanctions being taken against the joint venture and DEC for
failing to dispose of components properly and publishing misleading
information. It may also cast doubt on the other information DEC
publishes.
(2)
(i)
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Another issue that may arise is that the joint ventures year end is
different from the rest of the group. The joint venture produces
financial statements to 31 March each year whereas the Aybe group
produces its financial statements to 31 December each year. As there is
a difference, this will impact on the audit and additional procedures
must be performed on the financial information so that the group
financial statements can be prepared correctly.
Treatment of the joint venture
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There is a risk that the African company may not be a going concern
and hence that the financial statements at the year-end could be
produced on an incorrect basis. The indicators of going concern issues
include the fact that sales within the country are low and sales to
neighbouring countries have not begun. As a result, inventory has built
up which may not be able to be sold. Another factor which could result
in going concern issues is the potential litigation arising from the
company irresponsibly dumping toxic waste from old components
customers may wish to steer clear of such a company and the probable
adverse publicity resulting from this could cause the company to fail
ultimately.
Toxic waste disposal
It has recently been discovered via internal audit that old components
are not being disposed of in accordance with African legislation. This
could result in fines and penalties being imposed on the company.
Provisions may be required in the financial statements from possible
litigation and as this is a judgemental area, any potential provisions
could be under or overstated.
Valuation of inventory
As a result of low sales within the country and exports not commencing
as yet, inventory has built up. There is a risk that this inventory may
not be able to be sold due to technological obsolescence and therefore
its value may be overstated in the financial statements. Inventory
should be valued at the lower of cost and net realisable value in
accordance with IAS 2 Inventories.
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(ii)
Ethical issues
New legislation in Europe and the African country where the joint
venture is based requires components to be recycled in order to
minimise the damage to the environment. Consequently customers of
DEC have been informed that they can return old components to DEC
for recycling in accordance with the new legislation. Whilst this has had
a positive impact on the company, internal auditors have found that
some staff are not carrying out the recycling to comply with the
legislation but are simply dumping the old components.
The ethical implications of this include a lack of integrity being shown
by DECs management. Integrity means being straightforward and
honest. If the company has made the assertion in its social and
environmental report that it recycles old components in accordance
with legislation but is, in fact, not always doing so, it is not acting with
integrity. Indeed, the Chief Executive of Aybe has stated in the annual
report that Aybe will continue to apply the highest ethical standards in
its business activities. This appears not to be the case.
Furthermore, the company is not acting in the public interest if it is
sometimes throwing old components away. By doing so, it adversely
affects the environment and this is not in the public interest. This
results in the ethical principle of professional behaviour being
breached by the company not always complying with the recent
legislation on the recycling of potentially toxic components.
So we can see that the actions of some staff of DEC will result in both
non-compliance with legislation and non-compliance with CASLs Code
of Ethics.
There are several potential consequences for the company as a result
of this behaviour.
Firstly, there will be a reputational risk for the company and the group.
If the information gets into the public domain, this will have an adverse
effect on the company and the group as a whole. Shareholders and
potential investors may lose confidence in the company and this could
lead existing shareholders selling their shares and a fall in the share
price. Institutional shareholders are already getting restless because
they feel the group is not achieving good rates of growth and this latest
issue may push them to sell.
The whole groups reputation for reliable reporting may be in doubt,
particularly as Aybes Board has stated that it is a responsible
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Control environment
The board should consider whether Aybe's control environment encourages
ethical behaviour. This has various dimensions, including the board being
seen to act ethically. A code of ethics and ethics training should help. It is
also important that unethical behaviour in other areas of the business is not
tolerated. Action should be taken for example to prevent components
containing toxic materials being simply thrown away, as not only is it
dangerous but it means that the social and environmental report is
misleading.
Personnel policies
Recruitment controls can reduce the likelihood of staff who are likely to act
dishonestly being employed. References given by applicants should be
checked with referees, and applicants asked to explain gaps in employment
records as these could indicate a spell in prison. Applicants should also be
asked whether they have been convicted of any offence involving
dishonesty. Aybe's employment handbook should make clear that staff who
are found guilty of unethical behaviour will be subject to disciplinary
action, including the threat of dismissal.
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