Q&A Chapter 3: Planning engagements

Question 1

Audit risk: Long association

Answer 1

JUSTIFICATION: - Familiarity/trust/complacency threats
- Auditors may be over influenced by personality and qualities and directors
- Auditors may become too trusting of written representations by management – insufficient rigorous testing b3ecause they are too familiar with the issue ACTIONS: - Periodic rotation of senior staff.
- Engagement partner (ES4)
o Listed: 5 years / 5 years cooling off
o Unlisted: 10 years – consider if they should continue
- Key partner/senior staff (ES4)
o 7 years / 2 years cooling off

Question 2

Audit risk: Close family

Answer 2

JUSTIFICATION: If position of influence in client is a close family member ACTIONS: - Audit firm can do audit – but individual cannot be involved

Question 3

Audit risk: Gifts

Answer 3

JUSTIFICATION: - Familiarity / self-interest – bribe (each firm sets own limits)
- Remove objectivity
ACTIONS: - NO unless “clearly insignificant” or “trivial”

Question 4

Audit risk: Fees (contingent fees, overdue fees and non-audit fee limit)

Answer 4

JUSTIFICATION: - Contingent audit fees = banned
- Overdue fees: could affect audit if the client owes lots of money
- Fee limits: fear of losing client could affect judgement ACTIONS: Overdue fees – prior year fees must be paid before current year appointment.
If not paid – inform ethics partner and stop work… consider resigning
Fee limits: (audit+non-audit fees for client)/(total recurring practice income)
Listed: 10% is too much… 5% consider
Unlisted: 15% is too much… 10% consider
Inform ethics partner, independent review before sign-off, may have to reduce work load, or resign and don’t get reappointed

Question 5

Audit risk: Employment

Answer 5

JUSTIFICATION: - Familiarity threat: too much reliance on representations of former employee – too trusting

• Former self-interest threat (as manager this person may have been too sympathetic)
• Intimidation threat ACTIONS: - Engagement partner/ independence partner/ key partner – if they move into a position of key management for client, KPMG must resign audit. If vice versa - client becomes key partner, they can’t work on audit for 2Y
• Senior associate manger – if

Question 6

Audit risk: Financial connections

Answer 6

JUSTIFICATION: - Self-interest: could affect share prices ACTIONS: - Loans ok if ordinary loans – immaterial to both client & firm
- Not allowed if loan influences audit process

Question 7

Audit risk: Additional services (generic)

Answer 7

JUSTIFICATION: - Self-review threat – auditors may be reluctant to challenge adversely the outcome of a previous engagement or report on colleague’s work
- Possible low balling – low audit fee may be set in order to retain lucrative consultancy work (Why is this a problem?)
ACTIONS: - Use of different teams with separate reporting lines
- Independent partner review of the audit

Question 8

Audit risk: Valuation services

Answer 8

JUSTIFICATION: - Valuations services are not permitted by ES5 where the valuation would both
o Involve a significant degree of judgement, and
o Have a material impact on the FS
- ES5 par 77
ACTIONS: - No valuations work be undertaken

Question 9

Audit risk: IT services

Answer 9

JUSTIFICATION: Risk of self review

ES5 par 73 ACTIONS: - NO work on IT systems for which accounting system places sig. reliance

Question 10

Audit risk: Litigation and legal services

Answer 10

JUSTIFICATION: - Self-review threat / advocacy threats
- E.g. acting as witness / solicitor
- ES5 par 113
ACTIONS: - Do NOT accept services (unless unlisted clients, or clearly not subjective)

Question 11

Audit risk: Corporate finance services

Answer 11

JUSTIFICATION: - Advocacy, management, self-review threats
- E.g. advice on listings, takeover, financing
- ES5 par 131 ACTIONS: - Should not be accepted unless safeguards:
o Independent teams
o Independent partner review
o External independent advice

Question 12

Audit risk: Recruitment and remuneration

Answer 12

JUSTIFICATION: - Management threats and familiarity
- ES5 par 115, 117, 121
ACTIONS: Shouldn’t be performed without safeguards.

Question 13

Small entities: ESPACE

Answer 13

JUSTIFICATION: - ESPACE: ES Provisions Available for Small Entities
- Small company – 2 out of 3 applies:
o Employees not more than 50 employees
o Revenue doesn’t exceed £6.5m
o Gross assets

Question 14

Audit risk: Internal audit

Answer 14

JUSTIFICATION: - Management threat as may be decisions over scope of internal audit, self review threat as reliance may be placed on internal audit reluctant to highlight errors
- ES5 par 63 ACTIONS: - Firm shouldn’t take on audit whereby external audit opinion is based on significant reliance on its internal audit role.

Question 15

Audit risk: Tax services

Answer 15

JUSTIFICATION: - Management threat ACTIONS: - Firm shouldn’t take on audit whereby external audit opinion is based on significant reliance on its internal audit role

Question 16

Audit risk: Transaction related services (DD work)

Answer 16

JUSTIFICATION: - Management threat

• E.g. DD
• ES5 par 99 ACTIONS: Shouldn’t be performed without safeguards

Question 17

Audit risk: Restructuring services

Answer 17

JUSTIFICATION: Management threat, advocacy, self-review ACTIONS: - Entity plans to change capital structure – if entity in financial distress, they can only act in an advisory capacity

Question 18

Audit risk: Accounting services

Answer 18

JUSTIFICATION: - Management threat, Self-review threat
- ES5 par 1670, 164
ACTIONS: - Providing accounting services for listed audit clients is banned except in emergencies
- Firms must never find themselves in a management role

Question 19

What are the fundamental principles?

Answer 19

Integrity, objectivity, pro comp and due care, confidentiality, professional behaviour

Question 20

What are the main threats to objectivity and independence?

Answer 20

Self-interest threat
Self-review threat
Advocacy threat
Familiarity threat
Intimidation threat

Question 21

What happens if one partner gets the assurance wrong?

Answer 21

All partners could be laible

Question 22

Deciding if a client is risky or not: financial statements

Answer 22

GOOD: always available on time, requiring few adjustments, adequate supporting documents
BAD: late, requiring amendments

Question 23

Deciding if a client is risky or not: accounting and finance

Answer 23

GOOD: financial statements prepared by qualified chief accountant, adequate finance team
BAD: poorly led, temporary staff, over worked

Question 24

Deciding if a client is risky or not: IT systems

Answer 24

GOOD: well designed, integrated, bespoke, tested by internal audit
BAD: lots of systems, poor track record of success

Question 25

Deciding if a client is risky or not: policies and procedures

Answer 25

GOOD: well documented, and reviewed regularly
BAD: poor leadership, doesn’t stick by them

Question 26

RAND What are the steps of contacting an ex auditor?1

Answer 26

1) ask client
2) client gives old auditors permission to reply
3) request info (no response, send ordered delivery saying that we will accept if you say nothing)

Question 27

RAND Before an audit starts, what are the legal requirements

Answer 27

• Must be appointed by ordinary resolution (>50% need to vote in favour)
• appointment must be made by the end of the 28 days after the last date on which the accounts must be filled
• exception: to fill a casual vacancy (resignation) or to appoint the first auditor between date of incorporation and AGM

Question 28

RAND Why and how could an auditor be removed

Answer 28

• scandal, fees, incompetence, change in business

- must have ordinary resolution with special notice at a general meeting… written representation must be given

Question 29

Audit risk: attending board meetings

Answer 29

THREAT: management…
ACTIONS: can only act in advisory capacity, auditor should make this known to the managers, decline offer to attend meetings just to er on side of caution

Question 30

Quality issue: senior not spending much time

Answer 30

poor leadership, issues not sorted on a timely basis, poor training [discipline him]

Question 31

Quality issue: audit overrunning

Answer 31

poor control, poor planning [better planning more resources]

Question 32

Quality issue: complex for trainee

Answer 32

shouldnt be given, more likely to have errors and omissions [proper allocation, training, signed off by partner]

Question 33

Quality issue: bonus

Answer 33

independence threat, pressured to get the right result [dont accept the bonus]

Question 34

RAND: whats in a cash flow

Answer 34

IN

• cash proceeds from sales, timing
• cash costs to acquire new equipment (based on industry standard prices)
• amount timing of bank loans - speak to bank?

OUT

• interest payments - look at bank contract?
• expected level of inflation
• rent (timings, amount, see contract)
• wages and salary
• finance costs
• operating costs
• professional fees
• legal fines etc…

Sensitivity analysis should be performed for a variety of the unpredictable items (interest rate/exchange rates)

Question 35

RAND: what is in a profit forecast?

Answer 35

• interest on bank loans accrued to end of each year
• sales data, prudent forecast
• useful life estimate of new equipment
  depreciation: ]
• new equipment depreciation from ‘available for use’
• old equipment depreciated up to point of sale

Question 36

RAND: walk through vs. test of control

Answer 36

Walk through

• understand the controls/the system
• internal controls exist/documented

Test of control

• designed to obtain sufficient appropriate evidence as to operating effectiveness of relevant internal controls
• may allow for reduced substantitive procedures to be taken
• helps choose the sub procedures (where are weak spots)

Question 37

Audit Risk: assistaing year-end closing journals and preparing FS

Answer 37

• only permited for non-listed companies
• not permitted for listed clients unless for an emergency
• but separation (no involvement in audit of FS)
• assistance must be of a TECNICALM MECHANICAL OR INFORMATIVE NATURE.
• MANAGEMENT TAKE ALL DECISIONS REQUIRING EXERCISE OF JUDGEMENT
• refer to ethics partner