Day 1

First session

ETHICS
AUDIT RISK
 ETHICS
OT case: Blueberry & Co
1: Caving Co Part C (M/J 17)
2: Pink Panthers (S/D 15)
 OT Case: Blueberry & Co
Background:
• You are the audit manager of Blueberry & Co and you are planning the audit of
Mulberry Co, a listed company, which has been an audit client for four years and
specialises in manufacturing luxury mobile phones.
• During the planning stage of the audit you have obtained the following
information. The employees of Mulberry Co are entitled to purchase
smartphones at a discount of 10%. The audit team has in previous years been
offered the same level of staff discount.
• During the year the financial controller of Mulberry Co. was ill and hence unable
to work. The company had no spare staff able to fulfil the role and hence a
qualified audit senior of Blueberry & Co was seconded to the client for three
months to cover the work of the financial controller. The audit partner has
recommended that the audit senior work on the audit as he has good knowledge
of the client. The fee income derived from Mulberry Co. was boosted by this
engagement and along with the audit and tax fee, now accounts for 16% of the
firm's total fees. (15.7% last year).
• From a review of the correspondence files you note 20% of last year's audit fee is
still outstanding.
 TASK 1
Based on the information above you have summarised some of the
potential risks to independence in the audit of Mulberry Co. as follows.
(1) The audit team has been offered a discount on luxury phones
(2) The audit senior was seconded to Mulberry to cover for the financial
controller
(3) Total fees from Mulberry is over 15% of the total fees of the firm for the
second consecutive year
(4) Fees are overdue in respect of last year's audit
Which of the following options best identifies the SELF INTEREST threats
to independence in the audit of Mulberry and allocates the threat to the
most appropriate category?

Answer: Statement 1, 3 & 4

TASK 2
• You have also discovered that the engagement partner and the finance
director have known each other socially for many years, and in fact went
on holiday together last summer with their families to the finance
director's villa.
• Which TWO threats to independence are raised by this relationship and
what safeguards should be applied?
Option statement Answer

1 Familiarity and self-interest; Blueberry & Co to

resign as auditors
2 Self-review and intimidation; Rotation of audit
partner
3 Self-review and intimidation; Blueberry & Co to
resign as auditors
4 Familiarity and self-interest; Rotation of audit correct
partner
TASK 3
• In relation to the audit team being offered a 10% discount on mobile
phones:
• Which of the following statements is true in accordance with ACCA's
Code of Ethics and Conduct?

Option statement Answer

1 The audit team can accept the discount as it is on the same
terms as that offered to staff
2 Junior members of the audit team are allowed to accept
the discount, but the audit manager and audit partner
should not
3 Unless the value of the discount is trivial and correct
inconsequential to the audit team members, the offer
should be declined
4 The audit team is only allowed to accept a discount of up to
5%
 TASK 4
• Which of the following steps must Blueberry & Co take, as the fees
from Mulberry have exceeded 15% for the last two years?
(1) Resign from the audit
(2) Disclose the matter to those charged with governance
(3) Arrange for a pre- or post-issuance review

Option Answer
1 1 only
2 2 only
3 3 only
4 2 and 3 correct
TASK 5
The finance director of Mulberry Co. has made some enquiries about the other
services that Blueberry & Co may be able to assist with.
In the table below indicate whether Blueberry & Co would or would not be able
to provide the other services.

Option Answer
1 Design and implementation of IT systems over financial reporting TRUE FALSE

2 Assistance with preparation of tax return TRUE FALSE

3 Accounting services TRUE FALSE

4 Recruiting service for the position of credit controller TRUE FALSE

 Caving Co
(1) Financial results.
• The Finance director (FD) is keen to report Hurling Co’s financial
results earlier than normal.
• This may create an intimidation threat.
• Objectivity and quality of audit performed compromised.

Safeguard:
• Engagement partner should discuss timing of audit with FD.
• If not possible, inform that audit will be performed according to ISAs
and quality control procedures.
• If intimidation threat continues, Caving & Co may consider resigning.
 (2) Assist in recruiting
• NED of Hurling Co resigned, directors asked whether partners of Caving
& Co can assist in recruiting to fill this vacancy.
• This represents self-interest threat.
• Especially a NED who will have a key role in overseeing audit process
and audit firm.

Safeguard:
• Caving & Co can review shortlisting, qualifications and suitability of
candidates.
• Firm must not take management decisions.
 (3) EQCR
• EQCR assigned to Hurling Co was until last year audit engagement
partner.
• This represents a familiarity threat.
• Partner will have been associated with Hurling Co for long period.
• Partner may not retain professional scepticism and objectivity.

Safeguard:
• Hurling Co is a listed company, previous audit engagement partner
should not be involved in the audit for at least a period of two years.
• An alternative EQCR should be appointed instead.
 (4a) Other services
• Caving & Co provides taxation, audit engagement and recruitment of
NED related services.
• Potential self-interest or intimidation threat arises.
• As total fees could represent a significant proportion.
• Over reliance on Hurling Co result less challenge and objectivity.

Safeguard:
• Assess whether audit, recruitment and taxation fees would represent
more than 15% of gross practice income for two consecutive years.
 (4b)
• If recurring fees exceeds 15%, consider whether other services
should be undertaken by firm.
• If fees do exceed 15%, then disclosed to TCWG at Hurling Co.
• If firm retains all work, arrange for pre-issuance or post-issuance
review.
 (5) Contingent fee
• Audit fee is based on PBT constitutes a contingent fee.
• Self-interest threat arise.
• Contingent fees are prohibited under ACCA’s Code of Ethics and
Conduct.
• If audit fee is based on profit, team may ignore audit adjustments
which could reduce profit.

Safeguard:
• Caving & Co will not be able to accept contingent fees.
• Communicate to TCWG that external audit fee needs to be based on
time spent and levels of skill and experience required.
 (6) Outstanding fee
• 20% of last year’s audit fee is still outstanding
• A self-interest threat arise if fees remain outstanding.
• Caving & Co may feel pressure to agree to certain accounting
adjustments.
• outstanding fees could be perceived as loan to a client which is
strictly prohibited.

Safeguard:
• Discuss with TCWG the reasons why fee has not been paid.
• Agree a revised payment schedule which result in more fee settled
earlier.
 Pink Partners
(1) Family
• FD is sister-in-law of audit engagement partner, hence a family
relationship.
• There is familiarity and self-interest threat.
• Audit partner and FD are in position to influence outcome of audit.
• They may place family relationship above needs of users of F/S.

Safeguard:
• As it is sister-in-law, it is advisable to remove audit engagement
partner and appoint alternative partner.
 (2) Financial controller role
• Golden Finance Co’s (Golden) FD asked if audit team member can be
seconded to fill role of financial controller.
• A self-review risk arises if team member prepares records and
schedules.

Safeguard:
• Pink Partners & Co (Pink) should clarify which areas seconded team
member would assist
• As financial controller, member will be directly involved in dealing
with items related F/S.
• As such, request should be politely declined, or member should be
removed.
 (3) Significant loans
• Two members of audit team owe significant loans to company.
• Golden is banking institution and hence provision of loan is within
normal course of business.
• if either of loans has any preferential terms, this would represent a
self-interest threat.

Safeguard:
• Review terms of loan to ascertain whether they are in any way
preferential.
• If not, no further action is required.
• If terms are preferential, then either amended terms or remove
members from audit team.
 (4) Tax Issue
• Golden has requested Pink’s tax department to represent them to
resolve issues with taxation authorities.
• There is potential advocacy threat.
• Independence of firm is compromised.
• Outcome of these issues may have a material impact on F/S, resulting
in self-review threat.

Safeguard:
• It is advisable that the firm politely declines this request.
 (5) Taxation fee
• The taxation fees being quoted to Golden are substantial.
• There is self-interest threat as total fees could represent a significant
proportion.

Safeguard:
• Assess whether audit, non-audit and total taxation fees would
represent a significant proportion of recurring fee income.
• If recurring fees are likely to be significant, consider as to whether
taxation and/or non-audit assignments should be undertaken by firm.
 (6) Football and Meal
• FD has invited whole team to attend an evening out watching football
followed by a luxury meal.
• This represents a self-interest and familiarity threat.
• Acceptance of goods and services, unless insignificant in value, is not
permitted.

Safeguard:
• Football tickets and luxury meal has an insignificant value, then this
offer should be politely declined.
 AUDIT RISK

1: Caving Co Part A and B (M/J 17)

2: Earl & Co Part C (S/D 18)
 Caving Co
PART (A)
Audit risk: auditor expresses an inappropriate audit opinion when F/S
are materially misstated.
• Two components : risk of material misstatement and detection risk.
• Risk of material misstatement: inherent risk and control risk.

Inherent risk: Inherent risk is the susceptibility of an assertion about

a class of transaction, account balance or disclosure to a misstatement
which could be material, either individually or when aggregated with
other misstatements, before consideration of any related controls.
Control risk: risk that misstatement which could occur in an
assertion about a class of transaction, account balance or disclosure
and which could be material, either individually or when aggregated
with other misstatements, will not be prevented, or detected and
corrected, on a timely basis by the entity’s internal control.

Detection risk: risk that the procedures performed by the auditor to

reduce audit risk to an acceptably low level will not detect a
misstatement which exists and which could be material, either
individually or when aggregated with other misstatements.
Detection risk is affected by sampling and non-sampling risk.
PART (B)
(1) WEBSITE UPGRADED
• Website upgraded at cost of $1.1million. Cost should be correctly
allocated b/t capital and revenue expense.
• New process and system may not record data.
• Risk over completeness and accuracy of data.

Response:
• Review a breakdown of the costs and agree to invoices
• Undertake tests over completeness and accuracy of data recorded
from website to accounting records.
(2) NEW WAREHOUSE
• New warehouse purchased for $3·2m and legal process completed by
year end.
• Assets physically exist should be included in PPE at year end.
• If transaction not completed, there is risk that assets are overstated.

Response:
•Discuss with management as to whether the warehouse purchase
was completed by the year end.
•If so, inspect legal documents of ownership.
(3) IRREDEEMABLE PREFERENCE SHARES
• Company issued $5m of irredeemable preference shares.
• This finance needs to be accounted for correctly, with adequate
disclosure
• Should be classified as equity rather than non-current liabilities.
• Failing to correctly classify could result in understated equity and
overstated non-current liabilities.
Response:
• Review share issue documentation to confirm that preference
shares are irredeemable.
• Confirm that they have been correctly classified as equity.
• Review disclosures to ensure compliance with relevant accounting
standards.
(4) FIXTURES AND FITTINGS
• FD has extended useful lives of fixtures and from three to four years,
resulting reduced depreciation charge.
• Under IAS 16 PPE, useful lives are to be reviewed annually, if asset
lives genuinely increased, then this change is reasonable.
• Risk is that reduction occurred to boost profit.
• Hence, fixtures and fittings are overvalued and profit overstated.

Response:
• Discuss with directors rationale for any extensions and reduction of
depreciation rates.
• Assess the useful life of assets.
(5) RECEIVABLES
• A customer facing difficulties paying outstanding balance of $1·2m
and Hurling Co has agreed to revised credit period.
• There is an increased risk that receivable is not recoverable and
hence is overvalued.
Response:
• Review revised credit terms and identify if any after date cash
receipts for this customer have been made.
• Discuss with FD whether he intends to make an allowance.
• If not, review existing allowance for uncollectable accounts is
sufficient to cover amount of this receivable.
(6) SALES RELATED BONUS SCHEME
• Sales-related bonus scheme has been introduced resulted 5%
increased revenue.
• Sales staff seeking to maximize their current year bonus may result
in poor credit risks leading to irrecoverable receivables.
• Risk of sales cut-off errors as new customers could place orders
within the two-month introductory period and subsequently return
these goods post year end.
Response:
• Increased sales cut-off testing will be performed.
• Review of any post year-end returns as they may indicate cut-off
errors.
• Increased after date cash receipts testing to be undertaken for new
customer account receivables
(7) PRODUCT RECALL
• Product recall has been initiated for goods sold in last four months.
• If there are issues with quality, inventory may be overvalued as its
NRV may be below its cost.
• Products recalled will result in paying customer refunds. Refund
liability should be recognized along with reinstatement of inventory.
• Failing to account for this correctly could result in overstated
revenue and understated liabilities and inventory.
Response:
• Discuss FD whether any write downs will be made to this product.
• Undertake testing to confirm cost and NRV of products in inventory.
• Review list of sales made of product Luge prior to recall, agree that
sales removed from revenue and inventory included.
(8) LEGAL ACTION
• Petanque Co intended to commence legal action for loss of
information and profits.
• If it is probable to make payment , a legal provision is required.
• If payment is possible, contingent liability disclosure is necessary.
• There is risk over completeness of provisions or necessary disclosure
of contingent liabilities.

Response:
• Caving & Co should write to company’s lawyers to enquire of
existence and likelihood of successful claim.
(9) COMPLETION OF AUDIT
• FD requested that audit completes one week earlier than normal.
• Reduced timing will increase detection risk and place additional
pressure on team in obtaining sufficient and appropriate evidence.
• Finance team have less time to prepare financial information lead to
an increased risk of errors in F/S.
Response:
• Confirm timetable with FD, If reduced, then consider performing an
interim audit to reduce pressure on final audit.
• Maintain professional skepticism and be alert to increased risk of
errors occurring.
(10) FINAL DIVIDEND
• Once F/S finalised, final dividend propsed by company.
• Dividend should not be provided for 20X7 F/S, as obligation only
arises once dividend is announced, which is post year end.
• In line with IAS 10, dividend should only be disclosed.
• If dividend included, will lead to an overstatement of liabilities and
understatement of equity
Response:
• Discuss issue with management and confirm that dividend will not be
included within liabilities.
• F/S need to be reviewed to ensure that adequate disclosure of the
proposed dividend is included.
 Earl & Co
PART A:
Analytical procedures (AP) can be used at all stages of an audit,
however, ISA 315 and ISA 520 identify three particular stages:
• During planning stage, AP used as risk assessment procedures.
• During final audit, AP can be used to obtain sufficient appropriate
evidence.
• At final review stage, AP assist auditor forming an overall conclusion
as to whether F/S are consistent with auditor’s understanding of the
entity.
 PART B
Ratio 20X8 20X7
Gross profit margin 7,410/19,850 = 37·3% 6,190/16,990 = 36·4%

Inventory holding period 1,850/12,440 * 365 = 54 days 1,330/10,800 * 365 = 45 days

Inventory turnover 12,440/1,850 = 6·7 10,800/1,330 = 8·1

Receivables collection 2,750/19,850 * 365 = 51 days 1,780/16,990 * 365 = 38 days

period
Payables payment period 1,970/12,440 * 365 = 58 days 1,190/10,800 * 365 = 40 days

Current ratio 4,600/(1,970 + 810) = 1·65 3,670/1,190 = 3·08

Quick ratio 2,750/(1,970 + 810) = 0·99 (3,670 – 1,330)/1,190 = 1·97

PART C
(1) DEVELOPING NEW PRODUCT
• Darjeeling Co has spent $0·9m on developing new product lines.
• Expenditure is classed as research and development under IAS 38.
• Research costs to be expensed to profit or loss and development costs to
be capitalised.
• Intangible assets could be overstated and expenses understated due to
misclassification.

Response:
•Obtain breakdown to verify that expense relates to development.
•Review documentation to determine whether costs relate to research or
development stage.
•Discuss accounting treatment with FD and ensure it is in accordance with
IAS 38.
(2) NEW MANUFACTURING LINE
• New manufacturing line costs include purchase price ($2·2m), installation
costs ($0·4m) and five-year servicing and maintenance plan ($0·5m).
• As per IAS 16, cost includes purchase price and directly attributable costs.
• Servicing and maintenance costs should not to be capitalized.
• Servicing costs should be charged to profit or loss.
• PPE and profits are overstated and prepayments are understated.
Response:
• Review purchase documentation for new manufacturing line to confirm
exact cost of servicing.
• Discuss accounting treatment with FD and level of any necessary
adjustment to ensure treatment is in accordance with IAS 16.
(3) BANK LOAN
• Company borrowed $4m loan from bank. Loan needs to be correctly
split between current and non-current liabilities.
• Additional finance costs (FC) has an interest rate of 5%. Omission of
FC lead to understated FC and overstated profit.

Response:
• Audit team has to confirm that $4 million loan finance was received.
• Review split between current and non-current liabilities and
disclosures
• Details of security should be agreed to bank confirmation letter
• Recalculate FC and confirm 5% interest rate from documentation.
• Agree interest payments to cash book and bank statements
(4) STOCK EXCHANGE LISTING
• To maximize success of potential listing in next 12 months F/S
should present best possible position and performance.
• Directors have incentive to manipulate F/S, by overstating revenue,
profits and assets.
Response:
• Experienced audit team should be allocated adequate time to obtain
understanding of client.
• Team needs to maintain professional scepticism and be alert to
increased risk of manipulation.
• Significant estimates and judgements should be carefully reviewed in
light of the misstatement risk.
(5) RECEIVABLE DAYS
• Receivables collection period increased from 38 to 51 days and
management extended credit terms.
• There is increased risk over recoverability of receivables as they may
be overvalued and expenses understated.

Response:
• Review receivables balances and consider adequacy of any allowance
for receivables.
• Extended post year-end cash receipts testing and review aged
receivables ledger to assess valuation.
(6) PRICE PROMISE
• Company made ‘price promise’ to match price of its competitors for similar
products.
• Customers are able to claim difference for one month after date of
purchase.
• Company should account for price promise in accordance with IFRS® 15.
• Company may be required to provide a refund.
• This is highly subjective area, with many judgements required.
• Directors may not have correctly accounted this resulting in overstated
revenue, under/overstated profits and liabilities
Response:
• Discuss with management basis of refund liability of $0·25m
• Obtain supporting documentation to confirm reasonableness of
assumptions and calculations.
(7) PRODUCT RECALL
• Product recall has been initiated for paint products any goods sold
since June and will result in Darjeeling Co paying refunds to
customers.
• Sales need to be removed from 20X8 F/S and refund liability
recognized.
• Inventory will need to be reinstated.
• Failing to account for this correctly could result in overstated
revenue, understated liabilities and misstated inventory.
Response:
• Review list of sales of paint product made between June and date of
recall, agree that sales have been removed from revenue and
inventory included.
(8)DAMAGED INVENTORY
• Company is holding a number of damaged paint products
• Inventory holding period has increased from 45 days to 54 days.
• Due to issue with paint consistency, quality of these products is
questionable and management is investigating whether these
products can be rectified.
• There is risk that inventory may be overvalued as its NRV may be
below cost.
Response:
• Discuss with FD whether any write downs will be made, and what, if
any, modifications will be required.
• Testing should be undertaken to confirm cost and NRV.
(9) PROFITABILITY
• Revenue has increased by 16·8% in year.
• Gross margin has increased slightly from 36·4% to 37·3%.
• This is significant increase in revenue and, along with the increase in
gross margin, may be related to increased credit period and price
promise promotion or could be due to an overstatement of revenue.
Response:
• During audit detailed breakdown of sales will be obtained.
• Discussed with management and tested in order to understand the
sales increase.
• Increased cut-off testing should be undertaken to verify that revenue
is recorded in right period and is not overstated.
(10) LIQUIDITY
• Payables payment period has increased from 40 to 58 days.
• Current ratio has decreased from 3·08 to 1·65.
• Quick ratio has also decreased from 1·97 to 0·99.
• Bank balance has moved from $0·56m to an overdraft of $0·81m.
• Company could be experiencing reduction in cash flow which could
result in going concern difficulties or uncertainties.
• These uncertainties may not be adequately disclosed in the financial
statements.
Response:
• Detailed going concern testing to be performed during the audit,
including the review of cash flow forecasts and the underlying
assumptions.