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Internal Auditing (Far Eastern University)

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FAR EASTERN UNIVERSITY

INSTITUTE OF ACCOUNTS BUSINESS AND FINANCE
ACT1202 – Auditing and Assurance Principles

Case Study No. 1 Answer Sheet

Name: Uy, Justine Aaron M. Section: 9

Student No.: 2018022811 Grade:

1. What are the procedures that an auditor performs before accepting a client or continuing an engagement?

Before the audit begins, the auditor performs pre-engagement acceptance or continuance procedures. This includes:

 an independence assessment;
 a pre-engagement assessment; and
 communications with the previous auditor (if applicable).

After this process, you can need:

 a letter that communicates the auditor’s independence and compliance with relevant professional standards;
and
 disclosure of all relationships between the auditor and the entity and its related entities that may affect the
auditor’s independence.

Once the pre-engagement assessment is complete, the auditor issues an Engagement Letter with:

 engagement objectives, scope and limitations;

 management's responsibilities;
 responsibility for adjustments;
 the auditor's responsibilities; and
 other matters, such as fees.

2. Using the company’s financial information, calculate relevant ratios to obtain a better understanding of the
prospective client and to determine how the company is doing financially. Compare the company’s ratio to the
industry ratios and identify any significant differences.

Company Ratios: 2020 2019 Industry Ratios: 2020 2019

ROE 8.99% 19.53% ROE 20% 18%

ROA 6.86% 15.08% ROA 15% 16%

Rec. Turnover 2.37 3.16 Rec. Turnover 4.3 5.2

Ave collection period 151.9 113.92 Ave collection period 83.72 69.23

Debt ratio .32 0.19 Debt ratio 0.3 0.25

Current ratio 2.09 4.37 Current ratio 1.15 2.11

Profit margin 4,39% 7.3% Profit margin 10.6% 12.4%

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 lOMoARcPSD|10181776

FAR EASTERN UNIVERSITY

INSTITUTE OF ACCOUNTS BUSINESS AND FINANCE
ACT1202 – Auditing and Assurance Principles

Case Study No. 1 Answer Sheet

 The company makes less returns compare to average if to be base on return on equities or assets compare to the
average company in the industry.
 The company also takes a longer amount of time to collect receivables compare to other companies in the
industry.
 The company has significantly less liabilities on 2019 compare to other companies on the industry but have
increased to the average liabilities the industry have on 2020 presumably due to COVID-19. The
shareholders/owners also seem to pull out most of their assets from the company.
 The company seems to have lower profit margin on both years compare to those seen on the industry.

3. What other information should be considered before accepting CEC as a client? How important are these issues
to the client acceptance decisions and why?

The most important X mark that can be seen to accept CEC as a client is their refusal to be able to discuss with the
previous auditor, this may not be seem much but being able to understand how and why there was a disagreement
regarding the company's policy in revenue recognition plays an important role to be able to classify the accounts the
company has correctly and without bias.

Secondly, due to the poor financial performance the company obtained due to the crisis, there might be an ethical
problem due to the classifications and data the company is able to provide, this might make CEC a hard client to be able
to obtain enough data to be able to produce a reliable report.

4. The prospective client also indicated its interest in obtaining tax services from the firm. What are the pros and
cons of providing this service to the company?

1 of the pros of being able to provide tax services for the same company you have audited is being able to analyze
whether the company is able to qualify to some tax deduction through compliance or payments that may lessen through
other accounting standard. Providing this service also constitute to another payment compare to ordinary auditing of a
financial statement making the same work pay more due to using the same data you have calculated for 2 types of work.

The cons of this is the company might need different person to audit and provide tax services to this company if 1 person
doesn't possess both skills required by the work, this might cause additional expense to the company if they lack the
manpower or doesn't have someone capable of providing so.

5. It was noted that a partner of the firm has an investment in a fund that has an equity to the potential client.
Would this situation constitute a violation of independence in accordance to Code of Ethics for Professional
Accountants in the Philippines?

I doubt that there is since he will only audit their financial reports and so. This may however give him the idea whether
the investment would make a profit and change his investment plans accordingly. However, he may not spread the said
news for this might potentially destroy the company's image and be a breach of trust to the employer.

6. Prepare a memo to the partner making a recommendation as to whether the firm should or should not accept
Central Energy Corporation as an audit client. Justify your position in light of the information in the case.

The company should accept Central Energy Corporation as there isn't any proof that it will harm the company's image or
any difficulties that may arise that weren't foreseen by the company, it is also difficult to obtain clients during this
difficult times so accepting the opportunity for this work may prove to be a good decision.

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FAR EASTERN UNIVERSITY

INSTITUTE OF ACCOUNTS BUSINESS AND FINANCE
ACT1202 – Auditing and Assurance Principles

Case Study No. 1 Answer Sheet

7. Prepare a separate memo to the partner briefly listing and discussing three to five most important issues or risk
areas that will likely affect how the audit is conducted if the prospective client is accepted and how the firm can
address such issues.

If there is difficulty in obtaining financial information, the company may audit only to the extent of the information
provided to them, however the lack of concrete material and evidence will be shouldered by CEC.

Should there be an issue regarding the standard of classification, following the company's procedure may in effect be
better as the information would be better classified as they have done so. In the event that there is a classification that
must be followed from the standard of accounting, making a recommendation letter or note stating how this will affect
the report of the auditor.

The issue regarding technology may be utilized as long as the auditor has sufficient knowledge regarding SAP and should
any further difficulties arise, the auditor is advised to ask for assistance from the internal auditor of the company.

The issue regarding the previous auditor may prove to be hard as his prior knowledge would prove to be sufficient and
important regarding the company process of auditing but this wouldn't be a problem as long as the auditor is skilled in
being able to obtain the information from the head of operations or whomever handles the specific account.

The major contracts which have different standard from the company may prove to be the hardest task due to revenue
recognition policy of the company and the complex nature of activities that the company performs. Managing to know
when the receivables may be collected from the accounting period to the extent of the duration of the contract the firm
has with the company may solve this problem.

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