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Department of Accounting and Information Systems

EXAMINATION

Mid-year Examinations, 2019

ACCT346-19S1 (C) Auditing

Minnie:         That's quite alright.  Henry, I read in a recent issue of the National Business Review that your company has recently acquired a subsidiary.

Henry:          Yes, through an exchange of shares we acquired all the shares in Himalayan Slumber Ltd.   They specialise in manufacturing tents. So, as you can imagine, they really complement our firm well. As a result of the acquisition, though, I will have to change the format of our income statement in order to accommodate the new equity-accounted earnings of the associate.  The purchase took place at a bad time for me.  I had to continually  divide  my  time  between  the  acquisition  and  the  new  computerised accounting system I was implementing.

Minnie:          Have there been any other significant changes since last balance date that you think I should be aware of?

Henry:           No,  nothing  of  real  significance.     In  accordance  with  our  asset  replacement programme, we replaced two old stitching machines that had reached the end of their useful lives.  Also, we laid off eight employees as a result of closing our dye plant three  months  ago.    You  may  remember  that  we  had  been  experimenting  with fluorescent tramping pack colours - it never really caught on.

Minnie:          To assist me with my planning I am going to need a copy of your last month's accounts.

Henry:           We're a bit behind on our monthly accounts at the moment owing to the departure of two of our accounting staff several weeks ago, but I can give you a photocopy of our latest aged debtors’ trial balance.  I'll make sure those monthly accounts are sent to you as soon as possible.

REQUIRED:

(a)         Based on the preceding information, identify six potential audit risks that Minnie will

need to address in the audit planning memorandum.  For each specific risk you identify, state:

(i)        a brief description of the risk 

(ii)       why it is a risk to the auditor;

(iii)      the financial statement account(s) affected by the risk;

(iv)      the account assertion you believe most affected by the risk (state only ONE assertion for each account); and

(v)       an appropriate audit response to the risk;

Prepare your answer in the following format:

Risk	Why an audit risk?	Account(s) affected	Financial statement assertion (one per account)	Audit response

TOTAL:  24 MARKS

QUESTION 2

The  following is  an  extract  from  an  online  article published  on  Stuff (www.stuff.co.nz)  on 13 June 2017.

Inappropriate accounting at Fuji Xerox NZ became constant practice

Hamish McNicol

Updated 09:06, June 13 2017

Five years of “inappropriate accounting” at Fuji Xerox continued because of incentives such as bonuses for staff and caused losses worth more than $230 million.

In April, Japan-based Fujififilm Holdings said it had set up an independent investigation committee to review the appropriateness of accounting practices at Fuji Xerox New Zealand (FXNZ). These related to certain sales leasing transactions occurring in or prior to 2015 at the New Zealand office products subsidiary, and were estimated to have caused losses worth $285m.

On Monday, Fujififilm said the head-offifice review had extended to its Australian businesses and its initial estimates of the losses had increased to nearly $500m.

The committee’s full report was not yet available in English but an outline of it released Monday night said FXNZ conducted some “inappropriate accounting” between 2011 and 2016. A problem with Fuji Xerox's “internal control” was found and the system for its management by Fujififilm was “inadequate”. It found the issues caused losses to shareholders’ equity at the parent company worth $230m in New Zealand, and $121m in Australia. They had overstated revenue by about $473m.

The main issue related to lease agreements called MSAs, which FXNZ wrongly recorded in its accounts and resulted in revenue being exaggerated. Consequently, there were many transactions where receivables could not be recovered because, among other reasons, the copy volume did not reach the target set at the time of executing the contract and the minimum usage fee was not clearly set. “That became constant practice.”

The report said FXNZ’s board was not effective, there was a concentration of authority with the managing director, and its business management process lacked transparency. Furthermore, New Zealand staff were incentivised to continue the practices.

“Inappropriate accounting of early sales recognition continued because there were incentives for the MD and employees of FXNZ such as commissions and bonuses, and that structure placed an emphasis on sales.”

REQUIRED:

(a)     Define the concept of the ‘control environment’ and discuss its elements. (4 marks)

(b)    Discuss the relevance of the concept of the ‘control environment’ to the external auditor. (4 marks)

(c)     Based solely on the information contained in the article extract above, evaluate the control environment at FXNZ.  Justify your answer. (4 marks)

(d)    Assume that you are the auditor of FXNZ.  Briefly discuss the impact of your evaluation in

(c) on:

(i)     your assessment of relevant components of the audit risk model; and

(ii)    planned audit testing (identifying, where relevant, specific accounts and corresponding assertions). (4 marks)

(e)     Discuss recommendations that could be made to Fujifilm Holdings on strengthening the

control environment at FXNZ. (4 marks) TOTAL:  20 MARKS

QUESTION 3

You are auditing the financial statements of Plod & Run Menswear (PRM) for the year ended 30 June 2019.  PRM owns and operates a number of retail outlets that sell several product lines: suits, pants,  shirts, and accessories.   Tests of controls have confirmed your original control assessment. Your audit programme now requires you to undertake substantive analytical review procedures on selected income statement items.  Anything above $5,000 is regarded as material. Below is an extract from the income statement for the 2 years ended 30 June 2018 and 2019:

2019             2018

($000)           ($000)

Sales                                             1,549            1,146

Cost of sales                                    932               726

Grost Profit                                   617               420

Expenses

Wages                                             324               280

Rent                                                 115               115

Depreciation                                     23                 20

Other expenses                               100                80 

Profit/(loss) before tax                    55              (75) 

QUESTION 5

The following is an extract from the ‘basis for opinion’ paragraph contained in the audit report produced by the audit firm William Buck Audit (NZ) Ltd on the 31 December 2018 financial statements of Promisia Integrative Ltd.  The audit report was dated 29 March 2019.

As disclosed in Note 2(b), the Group has incurred a substantial Net Loss for the year and has had a significant reduction in Revenue from previous years. The Group has commenced a restructuring programme in 2019, and has budgeted a Net Loss for 2019 from trading. As such, Note 2(b) discloses that the ability of the Group to continue operating as a going concern is dependent upon:

 the Group achieving its restructuring programme including an increase in revenue in Australia and a reduction in operating costs and cash outflows;

 the Group receiving funding in 2019 from the issue of 250 million shares at $0.001 per share as disclosed in Note 32(i);

 that the largest shareholder will not require repayment of the loan payable within twelve months of the approval of the financial statements as disclosed in Note 32(ii); and

 the group being successful in the outcome of the litigation by the Ministry of Health as disclosed in Note 32(iii).

We have been unable to obtain sufficient appropriate audit evidence in respect of the outcome of the restructuring programme and the litigation that would enable us to form an opinion about the Group’s ability to continue as a going concern and therefore determine the appropriateness of the going concern assumption.

REQUIRED:

(a)     Summarise the current professional responsibilities of auditors with respect to the going concern assumption. Clearly reference any auditing standard(s) referred to in your answer. (5 marks)

(b)    Based on the extract from the audit report above, identify the type of modified opinion that

would have been appropriate (i.e., qualified due to limitation of scope; qualified due to disagreement; adverse; or disclaimer). (3 marks)

(c)     Draft the appropriate modified opinion paragraph. (4 marks)

(d)    Based on the audit report extract above and your answer to (b), briefly explain and discuss the meaning and implications of William Buck Audit (NZ) Ltd’s audit opinion.   Your discussion should refer to (but not be limited to) the:

-   level of assurance provided,

-   likely reasons for the opinion,

-   factors likely to have been considered by the auditors before issuing their report, and

-   likely impact on current and prospective shareholders of Promisia Integrative Ltd.  (8 marks) TOTAL:  20 MARKS