Tutorial 1

Textbook Question 1
1-13

Demand for Auditing and Assurance

1. Principal and agency relationship
➢ there is a separation of control thus a need for accounting
2. Information asymmetry
➢ agent knows more than principal
3. Conflict of interest between the agent and the principal’s interest
➢ Agent should look after principal’s interest. But they might look after their own instead.
With Audit, increase assurance and confidence of user relying on the information to decision making, therefore
willing to appoint agent.

2-14
Type of Audit Type of Auditor
A Evaluate the policies and procedures of the Compliance Audit Government Auditor
Medicines and Healthcare Products Regulatory Operational Audit
Agency in terms of bringing new drugs to the
market
B Determine the fair presentation of Ajax Financial Statement External auditor
Chemical’s balance sheet, income statement Audit
and statement of cash flows
C Review the payment procedures of the Internal Control Audit Internal Auditor
accounts payable department for a large Compliance Audit
manufacturer Operational Audit
D Examine the financial records of a division of a Compliance Audit External Auditor
corporation to determine if any accounting Internal Auditor
irregularities have occurred – fraud not
confirmed yet so need to do internal control
audit first to collect more data
E Evaluate the feasibility of forecasted rental Operational Audit/ Internal Auditor
income for a planned student housing project Review of prospective External Auditor
financial information
F Evaluate a company’s computer services Operational Audit Internal Auditor
department in terms of the efficient and External Auditor
effective use of corporate resources
G Audit the partnership tax return of a real estate Compliance Audit Government Auditor
development company
H Investigate the possibility of payroll fraud in a Forensic Audit Forensic Auditor
trade union pension fund. External Auditor
2-16

Code of Professional Conduct and Ethics Actions that result in failure to comply with Code

1.Competence Jones hired two recent accounting graduates to conduct the

Possess professional qualification, have audit, whom were lacking in experience since they are new.
appropriate training and supervision Jones also did not give the accounting graduates any form of
appropriate training and supervision and only told them what
to do. They lack professional qualifications.

2.Objectivity Boucher agreed to pay Jones her normal audit fees plus a
Independent mind and in appearance percentage of the bank loan if it was granted. As such
contingent fee is present, maximise self-interest. Bias audit
opinion on order to help audit client to obtain maximum bank
loan for personal interest.

3.Due Care Jones’ audit report did not refer to any auditing standards and
Observe technical and professional standards no audit procedures were conducted to evaluate the
appropriateness of accounting policies used and the
reasonableness of accounting estimates made.

Auditing Standards SSA Actions that result in failure to comply with SSA

4.Capabilities and competence of staff to Jones hired two recent accounting graduates who lack
perform audit. Engagement partner to take experience and qualification to conduct the audit. The new
responsibility for direction, supervision and hires submitted the financial statements to Jones excluding the
performance of audit. (SSA 220) notes. There was no indication that she supervised the new
hires on the task of the audit.

5.Understanding of internal control relevant to Sally Jones told the new hires not to spend time considering
audit. (SSA 315) internal control but to concentrate on proving the
mathematical general accuracy of the general and subsidiary
ledgers and summarizing the data in the accounting records.
The role taken by Jones was more accounting rose than
auditors.

6.Sufficient and appropriate evidence to draw Sally Jones told new hires not to spend time considering the
reasonable conclusions on which to base audit internal control but to concentrate on proving the
opinion. (SSA 500) mathematical general accuracy of the general and subsidiary
ledgers and summarizing the data in the accounting records.
The substantial accuracy of the accounts was not being taken
into considerations, there may be sale being reported that did
not actually took place.
 7.Audit report to state that audit was The report did not refer to any auditing standards and no audit
performed in accordance with SSA. (SS 700) procedures were conducted to evaluate the appropriateness
of accounting policies used and the reasonableness of
accounting estimates made.

8.The report shall state that the audit includes Sally Jones did not collect substantial evidence hence, she
evaluating the appropriateness of accounting should not express any opinion. This is insufficient for Jones to
policies used and the reasonableness of provide an opinion that is true and fair. The opinion given is
accounting estimates made by management, as wrong.
well as evaluating the overall presentation of
the financial statements. (SSA 700)

9.The report shall contain either an expression Sally Jones reviewed the statements and prepared an audit
of opinion regarding the financial statements, report with an unmodified opinion. Jones should not have
taken as a whole. When an overall opinion expressed any opinion as a proper audit was not being
cannot be expressed, the reasons therefore conducted. Jones failed to collect sufficient evidence to given
should be stated. (SSA 700). an opinion.

Question 2 Discuss the implications of the audit junior’s note for the completion of
the audit, commenting on the auditor’s responsibilities in relation to laws and
regulations, and on any ethical matters arising
As you review thee audit working papers of Super Safe Warehouses Ltd, you come across the
following comments made by an audit junior: “For one of its warehouses, Super Safe leases
out individual self -contained storage areas to its customers. Customers are given keys
allowing them to access the storage areas at any time. The company’s employees seldom
enter the customers’ storage areas and there is minimal documentation required regarding
the nature of the items being stored at these areas. The management’s rationale is that, as
the storage contracts for this warehouse typically generate revenue of less than $10,000,
minimum documentation, supervision and monitoring is required. While visiting this
warehouse, the door to one of the customers’ storage areas was open, and what appeared to
be potentially radioact ive materials, are stored in large metal drums marked with warning
signs such as this: When asked about the items being stored, the warehouse manager
became very agitated, disallowed me to ask other employees about the matter, and
threatening me if managements alerted about the storage of these items. I did not
mention the matter to anyone else at the client.

SSA 250 Consideration of Laws and Regulations in an Audit of Financial Statements

There is a potential non-compliance committed by client as they had stored hazardous chemicals in the warehouse
without proper storage procedures. This can pose risks, endangering lives of employees working in the warehouse.
Non-compliance should be reported to those charged with governance (board of directors), relevant authorities
and upper management. Management should have provision for fines and penalties. If no provisions are made, it
may become a misstatement. Management’s license may be suspended and therefore impact the company’s future
(going concern risk), which may affect the financial statements.

SSA 250 sets out the objectives of the auditor as follows:

(a) To obtain sufficient appropriate audit evidence regarding compliance with the provisions of those laws and
regulations generally recognised to have a direct effect on the determination of material amounts and disclosures
in the financial statements;

(b) To perform specified audit procedures to help identify instances of non-compliance with other laws and
regulations that may have a material effect on the financial statements; and
(c) To respond appropriately to non-compliance or suspected non-compliance with laws and regulations
identified during the audit.

SSA 315 Identifying and Assessing the Risks of Material Misstatement Through Understanding the Entity and its
Environment
It is the auditor’s responsibility to identify and assess the risks of material misstatement in the financial statements,
through understanding the entity and its environment, including the entity’s internal control.
Confidentiality
• If the auditors decided to report the radioactive materials to the officials, they may need to consider if
they have breached the confidentiality of the company. Therefore, they will have to consider if they should
act on integrity or duty of confidentiality.
• They may consider seeking legal advice on the next appropriate step.

Warehouse manager’s aggressive attitude

The junior auditor may face intimidation threats when the warehouse manager become very agitated and
disallowed the junior auditor to ask about the hazardous material or not to report it to the management. This
would result in misstatement of material and incomplete auditing documentation which in turn would cause
health and safety hazards towards employees. The management would also not be able to take the appropriate
steps to manage the hazardous materials due to lack of knowledge of its existence.

• Manager’s attitude implies that he has something to hide

• Should be prompted to investigate further

SSA 260 and SSA 265 Communicating Deficiencies in Internal Control with Those Charged with Governance and
Management
Internal control deficiency
• Even though the storage contracts for the warehouse typically generate revenue of less than $10,000,
there should be strong internal controls within the company. The fact that there was only minimal
documentation, supervision and monitoring of the items indicates that there is a deficiency of the firm’s
internal control.
• Especially in the documentation of the nature of the items being stored at the storage space, where in
this particular situation, the potential radioactive material stored in the warehouse can pose as a hazard
which can potentially harm the health of the employees and even the public which will affect the firm’s
objectives in operational effectiveness and efficiency.

Communication to those charged with governance

• The junior auditor should have communicated to those charged with governance regarding the difficulties he
has faced during the audit which includes the warehouse manager’s aggressive attitude, his disallowance to
communicate with the other employees and his threats. Should have reported the deficiency of internal
controls as well to allow for improvements on the controls.

Textbook Question 3

Auditor and client will determine an audit budget. Time spent doing technical work for the audit engagement is
charged accordingly.

Utilitarian Theory - I have to recognize the trade-offs between the benefits and burdens of alternative actions and
focus on consequences and individuals affected.

Pros of recording social time Cons of recording social time

➢ Able to accurately reflect time spent on the ➢ Future audits for this client might be under-
engagement. This includes both doing budgeted because they would assume there
technical work and “social time” is no need to charge any time to social time.
 ➢ Helps future audit teams to be aware of ➢ Budget for audit might be exceeded. This
actual time needed for this engagement so would upset manager/ audit partner. I may
that they are able to budget accurately. be questioned by the partner as to why I
➢ “Social time” is part and parcel of the audit charged the social time to this engagement.
engagement and helps to build a better
relationship with the client.

The rights-based approach: I have a right to declare “social time” as it is considered hours spent on doing technical
work for the audit engagement.
On the other hand, I have a right to reject the client and not go for this “social time” and there is no need to
record this “social time”.

The justice-based approach:

I feel that it is fair to record “social time” because I went for it with my own time and I should record it. However,
my audit team may feel differently because it risks exceeding the budget and this would affect the reputation of
the audit team as they would get a bad evaluation.

Decision: To go for “social time” but not to record it.

Question 4 a) Identify the ethical dilemma Amos faces in relation to Company Plus
Ltd.’s revenue recognition method. (b) Propose TWO possible courses of action that
Amos could take and indicate the fundamental principle or principles involved. (c)
Based on your proposed courses of action in (b) above, advise Amos of the most
appropriate course of action in this situation
While reviewing the work of an Audit Associate in relation to revenue, Amos (audit manager)
discovered that CP (audit client) appears to be recognis ing revenues prematurely. He
discussed the matter with the Audit Engagement Partner, Ginny, who concluded that the
accounting method is satisfactory, because it is the client’s policy that has been used for
more than ten years. Ginny is certain PYM will lo se CP as a client if they disagree with the
CP’s revenue recognition method now. Ginny requested Amos to document their conclusion
about revenue recognition being appropriate and satisfactory in the audit file, as per prior
years. Amos confides in you tha t he still feels that the revenue recognition method is
inappropriate.

a. Amos noticed that Company Plus Ltd (CP) appears to be recognizing revenues prematurely. However, the Audit
Engagement Partner requested Amos to document their conclusion about revenue recognition being
appropriate and satisfactory. If Amos follows the order, he is not doing the right thing. If he does not follow
the order, PKMG will lose CP as a client. Dilemma: whether to document the revenue recognition is appropriate
and to be recorded according to the partner.

b. 1st possible course of action: Amos obey all instructions given by Ginny to recognise the revenue recognition
policy even though it is wrong. However, this will affect CP’s financial reporting and Amos’ objectivity is
threatened, leading to inappropriate audit opinion.

2nd possible course of action: Refuse to do what she tells you. Amos should highlight any material
misstatements from the financial statements in his audit report and when the audit opinion clearly states the
material misstatement (in appropriation of CP revenue recognition method) in the financial statement, Amos
is not associated with the misleading financial statements and thus, complies with the principle of integrity.

c. Amos should discuss with Ginny and request for permission to further audit CP to clear the misunderstanding.
If Ginny is persistent on her views in CP’s revenue recognition method is appropriate and does not approve
 your request to further audit, Amos may raise the issue to ethics/quality control partner within the firm on the
issue.

Tutorial 2
Textbook Question 1
EMGPQ19-17

A.
Situation/relationship between parties: Provision of non-assurance services
1st situation: Interpret financial statement
Different from preparing financial statements, E.g. Interpret sales margin

2nd situation: Corporate Finance

a) Provide forecasts and other analyses
b) Counselled on potential expansion plans
c) Counselled on banking relationship

Threats: Self-interest, Self-review and Familiarity

Significant: No
As long as don’t promote their shares
As long as don’t make management decision
Not violated as the auditor was not involved in any management decision.
Only advisory
B.
Situation/relationship between parties: IT and Other system services
Auditor asked by Audit client to assist in the implementation of IT control system

Threats to independence: Self-review threat

When auditing, the auditors would audit the IT system.
It does not involve financial reporting and produce information that is significant to client’s accounting
records or financial statement that will express an opinion. Hence, there is no violation of code.

Non-PIE PIE
If client is not a PIE, then any systems would be If client is a PIE, cannot implement systems that has
fine. internal control over Financial reports, Accounting
Provided the auditor does not make any Reports and Financial Statements
management decisions or operate the IT systems -
It would increase the significant of self-review
threat.

Situation/relationship between parties: Management recruiting services

Threats to independence: Familiarity threat

Familiar with the clients’ operation and procedures
The auditor helps to arrange the interview for the candidates and would not be involved in any decision
making for the client. The audit firm has involved in management responsibilities “Instruct and oversee the
training of current client personnel” which is prohibited to do so. Hence, there is violation of code.
Non-PIE PIE
Can recruit any positions Cannot recruit management positions.
However, cannot be in A/P Not make hiring decision and not involve in the
Not make hiring decision and not involve in the supervision the operating the team
supervision the operating the team

Conclusion
Therefore, the auditor could help out with the implementing of IT system and arranging of interviews for the
candidates but not to instruct and oversee the training of current client personnel.

C.
Situation/relationship between parties: Business & Personal relationship between KAP & Audit Client
Business relationship through joint venture to purchase of vacation home in Spain
Personal relationship as golfing buddies

Threats to independence: Self-interest threat and Familiarity threat

Self-Interest threat - Having a close business relationship (financial interest in a joint venture) with the client
may predispose Bob, the Key-Audit Partner (KAP) to take on a more optimistic audit opinion.
Familiarity threat - As the CEO of the Audit Client is a golfing buddy, the partner may choose to look after the
client’s interests and prevent issuing a qualified opinion which would reflect badly on the company to
external investors and creditors

Significant: Yes
Yes, because the common financial interests are material (10% or more).
Importance of business relationship not elaborated upon due to lack of information in the case.

In conclusion, is there a violation of the Code of Ethics?

Yes, there is a violation in the Code of Ethics. Must avoid completely.
D.
Situation/relationship between parties: KAP has Financial Interest in Audit Client
Having the shares in the trust appears to be Indirect Financial Interest. Although the financial interest seems
to be indirect, it is actually a Direct Financial Interest, as the KAP can make investment decision to hold or sell
off the shares of the trust. (Still maintain control over the shares)

Threats to independence: Self-interest threat

Self-Interest threat: May ignore material misstatements to give an unqualified opinion of the client’s Financial
Statements in a bid to drive up the stock price for his own profit.

Significant: Yes
Yes. The shares in the fund is substantial, making the financial interest material.

In conclusion, is there a violation off the Code of Ethics?

Yes, there is a violation in the Code of Ethics. Must avoid completely.

E.
Situation/relationship between parties: Close Family member has Material Indirect Financial Interest
The parents of the audit member own a condominium unit and resides in it. The amount is material to the
parent’s net worth.

Threats to independence: Self-interest threat

The audit member has close family members that have a material indirect financial interest in the audit client
and may help to look after their interest.

Significant: Yes
The threats are significant given the direct relationship of the audit member and the close family members
whereby they are family members whom see one another daily, and also the unit is material to the parents’
net worth.

Recommendation:
Audit member need to disclose such information (Financial interest) and should not be on the audit team for
this engagement for there to be no violation.
The member should also not be able to influence the judgement made by the audit team.

F. Situation/relationship between parties: Direct Financial Interest

Potential shareholder and client relationship

Threats to independence: Self-interest threat

Significant: Depends
There might be violation in the previous year’s audit if the agreed term of payment during the audit planning
meeting was to be paid in shares.
Regarding this year’s audit there is no violation, as the stocks payment were being disposed before the audit
engagement. However, if the term of payment is being based on stock payment again, there will be violation
due to self-interest.

Recommendation:
Agree on cash as payment term during the engagement meeting
Avoid this client all together.

G. Situation/relationship between parties: Fees Overdues

Audit firm provides other services such as tax-related services performed two years ago which the client Dip-
It has not paid Allen & Allen.

Threats to independence: Self-interest threat

 Audit firm may be inclined to provide a bias opinion to reduce the risk of client being unable to pay as
auditors are more concerned with the recovery of the overdue fees.

Significant: Depends
The firm shall determine whether the overdue fees are material and might be regarded as being equivalent to
a loan to the client. If the overdue fees are significant enough, the client should not be re-appointed or
continue the audit engagement due to self-interest threat.

Textbook Question 2
EMGPQ19-25

Situation: Employment with an Audit Client

Before Adrian joined Swiss Precision Tooling as an accountant, he used to work as a staff auditor under
Crowther.

Threat: Familiarity threat and Intimidation Threat

Audit firm may become too sympathetic to the interests of the Adrian as they are familiar with him.
Audit members of the audit firm might be intimidated and deterred from acting objectively by actual or
perceived threats.

Significance: Depends
In order to determine the significance of the threat, the code of ethics have listed the following four factors:
1.The position the individual has taken at the client’s firm
He was a staff auditor
2.Any involvement the individual has with the audit team
Adrian is now a junior member of Swiss Precision, he is unable to partake in the decision-making process or
has the ability to affect the financial statements.
3.The length of time
Adrian has only worked for Crowther for three months, which is a relatively short period, he may not have a
significant connection with Crowther. Thus, familiarity threat may not be significant in this situation.

4.The former position of the individual within the audit team, whether he is charged with governance
It was not known whether Adrian maintained regular contact with any of the members of his previous
company.

After evaluating the four factors, we conclude that there is low significance of familiarity threat.

B.
Situation: Employment with Audit Client
Susana previously worked as a KAPP in Burcham and is currently a controller of Ungated Dairies. As Ungated
is currently undergoing audit assignment from Burcham, Susana was an employment with the audit client.

Threat: Advocacy threat, Familiarity threat, Intimidation threat

1.The position the individual has taken at the client’s firm

Susana is currently holding a position as a controller in client’s company.
She will be able to make significant decision when communicating and providing evidence with the audit team
which might lead to advocacy threat.

2.Any involvement the individual has with the audit team

No. She is a controller.

3.The length of time

She was a partner was less than 2 years (19 months) hence might be familiar with the audit team members.

4.The former position of the individual within the audit team, whether he is charged with governance
As she was a KAP in the audit firm, she holds a high position, she used to lead the audit team, hence there
will be intimidation threat faced by the audit team.

Hence, with presence of high familiarity, intimidation and advocacy threat, the audit firm should avoid
auditing Ungated as they are already facing a violation of EP100, Employment with an audit client.

c.
Situation: Specialist Valuation services
Janay is aware that under the Code of Ethics there are clear limitations on which valuation services her audit
firm can perform for an audit client, but her manager has requested her to appraise some specific large
inventory items to verify the client’s estimates. (material & subjectivity)

Threat: Self-review threat

A valuation service may have a material effect on the financial statements on which the firm will express an
opinion, and the valuation involves a significant degree of subjectivity. The affected elements would be net
assets and goodwill.

Significance: Depends
Depending on the value of the inventory, if the valuation service is material enough, it is a significant threat,
then it would be a violation of the code of ethics, otherwise, there is no violation.

D.
Situation: Fees Relative Size Fee
The client (Halifax Investments) is a Public Interest entity and the amount of annual fees received for non-
audit services compared to the total annual audit fees from the audit client is more than 50%.

Threat: Self-interest threat

Audit firm focusing on non-audit services. They may be more concerned of losing income from provision of
non-audit services due to unfavourable opinions from audit services. Thus, this will hinder the objectivity of
the audit opinion.

Significance: Yes
 PIE and more than 50% for non-audit fees

Audit firm is required to disclose such facts to those charged with governance of the audit client and discuss
the safeguards they will apply to reduce the threat to an acceptable level. The fee figures have been
appropriately disclosed in the client’s financial statements as stated in the question.

Safeguards:
Independent internal or external quality control review of the engagement; and
Consulting a third party, such as a professional regulatory body or other professional accountant, on key
audit judgements.

Question 3 Provide a response to Steve which evaluates the ethical implications of his
request.
Maggie Lim, ethics partner AA LLP, informs you that she just had a conversation with Steve
Lim, the CEO of CS Pte Ltd, a company dealing with trad ing of electrical appliances. He would
like the audit engagement partner to attend the CSS’s board meetings on a monthly basis so
that your firm can be made aware of any issues relating to the audit as soon as possible. In
addition, Steve has requested for an audit manager to be seconded to CSS’s holding company
in temporary replacement of its finance director who recently left. He has also asked for the
audit firm in recruiting a permanent replacement.
Situation: Audit engagement partner attending board meetings
It is a statutory right of an auditor to attend AGMs and not Director’s meetings.
If auditors are invited to board meetings, they would be able attend the meeting if the objective is to share on audit
matters. Such audit matters include:
• The responsibilities of the auditor in relation to the financial statement audit;
• An overview of the planned scope and timing of the audit, which includes communicating about the significant
risks identified by the auditor;
• The auditor’s views about significant qualitative aspects of the entity’s accounting practices, including accounting
policies, accounting estimates and financial statement disclosures, etc.

Threat: Self-review, Self-interest, Familiarity

If the objective of the meeting is to appoint auditors as directors, the self-review and self-interest threat would be
too significant for any safeguards to be put in place. The auditors would not be able to serve as the director of the
audit client and if he wishes to do so would have to terminate his employment with the audit firm.
If the objectives of the meeting involve making strategic management decisions, the auditor too would not be able
to attend the meeting as it would affect his objectivity and give rise to familiarity, self-review and self-interest
threat.

Significance: No
Since the objective for the auditor to attend the meeting is to be aware on issues regarding to audit, he can attend
the meeting. Do not interfere with decision making of management.

Situation: Secondment of an audit manager to CS Group in a role as finance director

Temporary staff assignments.

Threat: Self-review and Familiarity threat

Lending of staff by a firm to an audit client may create a self-review threat. Such assistance may be given, but only
for a short period of time and the firm’s personnel shall not be involved in assuming management responsibilities
and providing assurance services to the client.

Significance: Yes
In this case, the audit manager who was seconded to CS’s holding company as a finance director will hold a
management position of the company. Additionally, assuming the audit manager is part of the audit team, he
should not be providing assurance services while holding a management role in CS Group.
 Situation: Recruitment of a new finance director to CS Group

Threats: Self-interest, familiarity, intimidation threat

Significance: Depends
As CS Pte Ltd is not a Public Interest Entity, according to the Code of Ethics, under management recruiting services,
members of the audit team can participate in reviewing the professional qualifications of a number of applicants,
providing advice on their suitability for the post, interviewing candidates and advising on a candidate’s competence
for their position. However, they should not be making the hiring decision as it will create self-interest, familiarity
or intimidation threats.

Question 4 Explain the ethical issues arising for the audit firm in respect of Ronnie’s
proposal
Ronnie San, a trainee ISCA Chartered Accountant, is working on the external audit of Persow
Ltd (Persow). Ronnie previously worked on the external audit of Majin Ltd (Majin), a car fleet
management company. Persow is se arching for a new car fleet management supplier and
Ronnie has proposed that his audit firm recommends Majin to Persow in return for a fee from
Majin for the introductio n.
Situation: Business Relationship
Ronnie San has a business relationship with his Audit Client, Person. Business relationship: distribution or
marketing arrangements under which the firm distributes or markets the client’s products or services, or the
client distributes or markets the firm’s products or services. He wants to a fee from Majin in return for
recommending them to Person.

Threat: Familiarity threat, Advocacy threat

Ronnie has recently worked as the external auditor of Majin Ltd and is aware of Majin Ltd.’s financial condition.

Significance: Depends
The nature of the relationship between Ronnie and Majin Ltd and the materiality of the financial interest.

Question 5 With reference to Ethical Pronouncements 100 issued by the Institute of

Singapore Chartered Accountants, for each of Audit Client 1 and 2, comment on the
issues, including any possible safeguards and actions that PK should take.
You are a senior manager in PK Choo LLP (PK) and are responsible for monitoring audit quality
and ethical situations which arise in relation to audit clients. You are currently conducting a
review of the quality of the audit of a few audit clients, for the financia l year ended
31stDecember 2017, and of any ethical issues which arose in relation to it and have some
concerns regarding the following matters.
Audit Client 1
During the audit planning meeting in August 2017, Steven Lim, the Managing Director of
Exotic Travel invited both the audit manager and the audit partner to the company’s newly
launched 15 Night Far East Cruise that retails at $4,000 per person. Steven Lim believes that
the outcome of the audit should be just like previous years when the audit opini on has
always been unqualified opinion so he would like to extend his appreciation to the audit team
in advance.
Audit Client 2
The board of directors of the client entity, which is listed on the Stock Exchange of Singapore,
has asked if your audit firm c an take on the following additional work:(1) Assist with the
selection of a new assistant accountant including the checking of references and interviewing
of candidates. The new assistant accountant is to report to the financial controller; and (2)
Decide on the design and implementation, and also operate an information system to collect
feedback from customers.
Audit Client 1
Situation: Gifts and Hospitality
Whether the acceptance of gift violates the code of ethics.

Threats: Self-interest, familiarity threat

Significance: Yes
Factor 1 (Timing): The audit manager and the audit partner were invited to the company’s newly launched 15 Night
Far East Cruise the offer was made during the audit planning meeting before audit conclusion.
Factor 2 (Value): Night Far East Cruise that retails at $4,000 per person. The value of the gift is sum up to $8,000,
which deemed significant.
Factor 3 (Intention): To expect an unqualified audit opinion, the gift was only offered to senior member/KAPs as
they can decide on audit opinions.
Factor 4 (Nature): Cruise ticket

Hence, the gift should not be accepted.

Audit Client 2
Situation: Provision of non-assurance services

1st situation: Management recruiting services

To assist with the selection of a new assistant accountant that has to report to the financial controller
Threat: Self-interest, Self-review, Familiarity
Significance: No
The client is looking for an assistant accountant which will NOT have significant influence over the preparation of
the financial statements. Therefore, we are allowed to partake in certain aspects of the hiring of the new assistant
accountant.

2nd situation: IT and other system services

To decide on the design and implementation and also operate an information system to collect feedback from
customers.
Threat: Self-review
Significance: Yes
Audit client is a PIE, will not be allowed to provide services involving the design and implementation of the IT
system if it:
a) forms a significant part of internal control over financial reporting or
b) generate information that is significant to the client’s accounting records or financial statements on which the
firm will express an opinion.
In this case, as this is for collection of customer feedback, it does not involve financial reporting.
However, in this case, the IT service involves deciding and operating the system. Making decision on the system
amounts to making management decision. Hence, should not provide the service.
Tutorial 3
Textbook Question 1
5-6 – Explain why in most instances audit evidence is persuasive rather than convincing.
1. Audit evidence are said to be persuasive rather than convincing as it is not 100% accurate and complete.
Hence, risk is always present. To have 100% accuracy and assurance and will cost users a lot of money and time
and effort as there are more procedures to be done. In most cases, they do not need full assurance. Users are
willing to accept a certain amount of risk.
2. Reliability of evidence. Documents will not be entirely convincing because it can be forged photocopied or
falsify making these documents less reliable. Party who confirms the documents would affect the reliability
(Auditor/Audit Client/3rd Party). Evidence that are subjective estimates will not be convincing because nobody
can truly identify the actual value of the asset.

5-18
Management assertion about classes of transaction are: Required: For each management assertion, indicate an
example of a misstatement that could occur for revenue transactions.
a Occurrence (not real)
On the 20th January 2019, service is not performed but revenue has been recorded.

b Completeness (omission)
Sales revenue transaction of $100,000 were omitted.

c Authorization (not authorized)

Not included in SSA 500 (control objective, mentioned in Lecture 6)

d Accuracy (incorrect amount)

The transaction should be $500 but is recorded as $5,000 (Incorrect Amount)

e Cut Off (wrong period)

Transaction incurred in financial year 2017 is recorded in financial year 2018 (Wrong period)

f Classification (wrong category)

Incorrect recording in category. E.g. Assets being record as expenses

5-19

Type of audit procedure Account balance/ Classes of Assertion

transactions

a External confirmation AB - A/R Existence/ AVA

‘written request to third party’ ‘amount owed’
 b Inspection of records or document COT - Sales Transactions Cut-off
‘examining sales invoices’ ‘sales are recorded’ ‘proper period’

c Inspection of records or documents / AB - A/R GL Completeness

Reperformance
‘agreeing the total of the A/R subsidiary
ledger to A/R general ledger’

d Inquiry AB - A/R, provision Accuracy, valuation and

‘discuss. with credit manager’ ‘adequacy of DD’ allocation

e Analytical Procedures AB - A/R, A/P Accuracy, valuation and

‘compare gross profit % year by year’ allocation

f Inspection of tangible assets AB - FA/PPE Existence

‘examining new plastic extrusion machine’

g Observation AB - Inventory Existence / Completeness

‘watching personnel count.’ ‘raw materials inventory’

h Reperformance AB - Inventory Existence / Completeness

‘performing test counts’ ‘raw material inventory”

I External confirmation AB – Provision/ Contingent AVA /

’ obtain letter from entity’s lawyer’ liability Presentation(disclosure)
‘no lawsuits’

j Inspection of records or Sales transaction Accuracy

documents/reperformance
‘trace …sales invoices to approved price
list’

k Scanning GL accounts Various (No specifications)

‘review GL for unusual entries’

Q5-21
 a 1st Audit Evidence: Bank Confirmation
Bank is third party which is external and independent. They have more stringent control and regulated.
Therefore, not having any incentive to modify evidence, the information has high reliability. In addition, it
is obtained by the auditor, the process of acquiring the bank confirmation was never handled and
generated by the client and hence it also has high reliability.
*AR has vested interest to agree when the AR is understated.

2nd Evidence: Observation of segregation of duties between cash receipts and recording payment in a/c
receivable subsidiary ledger
False impression that controls are in place throughout the year, modify behaviour when under
observation→ give misleading information to auditor

Therefore, Bank Confirmation is more reliable.

b 1st Evidence: Examination of raw material requisition (an internal document)

Even though auditor examines source and meet the assertion of occurrence, it is still an internal
document.

2nd Evidence: Recalculation of depreciation.

Recalculation of depreciation by the auditor can meet the assertion of accuracy, that amounts are
recorded appropriately. Auditor has direct knowledge of the subject matter.

Therefore, recalculation of depreciation is more reliable.

c 1st Evidence: Assuming the bank statement is obtained from the bank
Bank is an entity that is external and independent to the client hence the bank statement is less likely to
be changed and it is also more difficult for the client or its employees to falsify the evidence.

2nd Evidence: Shipping documents (internal document)

Prepared by the client (details are written by client). Hence, less reliable and auditors will require
additional testing to substantiate the documents received from the client.

Therefore, Bank Statement is more reliable.

d 1st Evidence: Physical inspection of common stock certificates held for investment
A stock certificate is a legal document that certifies ownership that is provided by the corporation.
(Documents)

2nd Evidence: Physical examination of inventory components for personal computer

For computer components
→ hard to tell which component is which → hard to prove existence → need IT expert
→ may not be able to easily determine value or quality → AVA → need IT expert

Hence, Common stock certificates is more reliable.

Q5-22
Inspection of records and documents relates to the auditor’s examination of entity accounting records and
other information. One issue that affects the reliability of documentary evidence is whether the documents are
internal or external. Following are examples of documentary evidence:
Internal documents but circulated to external party, high reliability
Type Reliability Why?

1. Internal Low Duplicate copies of sales invoices

2. Internal Moderate Purchase orders is from AC hence internal. Depends on IC (strong/weak)

 3. External High Bank Statements is from bank, external party that is highly regulated.

4. Internal High Remittance advices is from customers, external party.

5. External High Vendors’ invoices are from vendors, external party.

6. Internal Moderate Material requisition forms is from AC hence internal. Depends on IC

(strong/weak)

7. Internal Low Overhead cost allocation sheets are from AC hence internal. Depends on IC
(strong/weak)

8 Internal Low Shipping documents is from AC hence internal. Depends on IC (strong/weak)

9. Internal Moderate Payroll payments are circulated to employees: checked and verified

10. External High Long-term debt agreement is a legal document; hence it has a high reliability.

Question 2 For each evidence described in (I) to (iii) relating to accounts payable,
(a)Explain the relevance and reliability of the evidence as a source of evidence to
confirm the completeness of the account’s payable balances. (b)If the evidence is
assessed to be not relevant or reliable, explain what further action the audit assistant
should take to confirm the completeness of the accounts payable balance
The audit working paper on accounts payable reported on the financial statements as at 31
December 2018documented the following comments: To test for the completeness of
accounts payable, the following evidence was obtained:(1) Confirmation replies from the
three largest accounts payables that amount to 60% of the total accounts payable balance.
They have agreed to the outstanding balances stated on the confirmation requests. (2)
Photocopies of supplier invoices and delivery orders that were received subsequent to 31
December 2017. These documents were not yet updated in the accounting records but they
reflected that goods have been received by Jade Electronics during December 2017. (3) Oral
explanation from the Chief Financial Officer regarding the decline in value of accounts
payable balance. He has explained that Jade Electronics has replaced a local supplier with a
supplier from Bangladesh .
Reliability: evidence must be trustworthy (reflecting the truth of matter)
Relevance: evidence must meet the audit objective which the auditor wants to achieve.
Test: completeness.
a. Relevance a. Reliability (b) Further action

(a) Confirmation replies from the three largest accounts payable that amount to 60% of the total accounts
payable balance. They have agreed to the outstanding balances stated on the confirmation requests.

Not relevant to completeness High Reliability Select active supplier with zero
Auditor select the 3 largest A/P. Derived from knowledgeable parties or small balance. (testing
(testing overstatements) external to the client – A/P understatements for
External A/P are unbiased as they have completeness)
no motivation to lie to the auditor or
help employees. Auditor must control
the confirmation process (receive the
confirmation replies personally)

(b) Photocopies of supplier invoices and delivery orders that were received subsequent to 31 December 2017.
These documents were not yet updated in the accounting records but they reflected that goods have been
received by Jade Electronics during December 2017.
Relevant to completeness Low reliability Audit assistant should wait and
Transactions occurred before year Photocopied documents and not request for original documents
end were not included in the A/P original. Client may falsify the original and cross check between
balance thus balance is understated documents in order to match the fake documents and company’s
and incomplete transactions if original documents are accounting ledgers
not available.

(c) Oral explanation from the Chief Financial Officer regarding the decline in value of accounts payable balance.
He has explained that Jade Electronics has replaced a local supplier with a supplier from Bangladesh.

Relevant Low reliability Inspect the purchase

Auditor has to find out the reason for The type of audit evidence involved is agreement and obtain email
decreases in A/P as compared to oral explanation. It is not reliable as confirmation with the suppliers
previous years. In Bangladesh, cost of this is mere words from the CFO of the regarding the account balance.
supplies lower, thus A/P balance company. There is nothing in B&W and
drop. CFO would know about major he would not have to be accountable
changes happening in the company for his own words. Moreover,
(e.g. change in supplier) and talking everything that he said could be false
to him would be getting information and he could lie to the auditor to cover
from the direct source. up the real reason of changing
suppliers. CFO also has significant
influence over the financial
statements.
Question 3 Identify the assertion tested for the audit work performed by the audit
staff. (b) Comment on the appropriateness of the evidence
You are the audit manager of Corner Store Pte Ltd, a company that manufactures modern
furniture. You are in the process of reviewing the audit team’s working papers for the year
ended 31 December 2017 and have noted the following matters: Property, plant and
equipment the equipment level is 20% h igher than at the start of the year . The audit senior
has documented in the audit working papers that: ‘An adequate explanation for the increase
in equipment level has been obtained from the Deputy Finance Director. He has explained
that the company has recently bought a new production equipment to meet the increase in
sales orders. The company’s sales level has indeed increased significantly as compared to last
year’. Accounts Payable In the auditing of accounts payable balance, the audit team select ed
a sample of five large items for direct confirmation: Two items were confirmed by telephone
One item with no reply so the audit team had agreed with copies of supplier invoices the
remaining two items were confirmed in writing by the suppliers. You noticed that of the two
confirmation replies, one was received through Corner Store’s internal mail system and
another was signed by a Mrs Susan Tan, whom you found out later that she is the wife of
Corner Stone’s CEO. Purchases Corner Store has many suppliers providing goods and services
and it is common that goods and services are delivered before supp orting documents are
received or recorded. In order to make sure that there is no omission in the recording of
purchase transactions, the audit team had selected a sample of purchase transactions
recorded in the purchases journal and vouched to suppliers’ invoices, goods receipt notes and
approved purchase understate tax charge and liability for the year have been calculated by
the audit manager. Due to some transfer pricing issues, Corner Store’s tax matter is quite
complex.
a. Assertion (b) Appropriateness of evidence

Assertions about Relevant: Yes

account balances (PPE) Adequate explanation from Deputy Finance Director, he knows about the company
1. Existence procedures etc.
2. Rights and
obligations Reliable: No
Finance director, an internal source, it is considered as an unreliable source of evidence.
It is not reliable and sufficient as there is no evidence that the equipment exists and
whether with the purchase of this equipment really led to the increase in the company’s
sales level.

Auditor should inspect the production equipment as claimed by the finance director,
inspect sales order.

Assertions about Relevant: Yes

account balances (AP) Copies of sales invoices are used
1. Existence
2. Accuracy, Reliable: No
Valuation and 1. Audit team confirmed the balance by telephone. This is a verbal confirmation. Verbal
Allocation confirmation not reliable because it can be retracted and misinterpreted
3. Rights & 2. Copies of supplier invoices as these documents were retrieved from client’s record
Obligations and they are duplicated, high possibility of being falsified.
3. One of the confirmation e-mails is a close family of the CEO. This means that the
evidence is not reliable as she might be helping to cover up some errors / fraud.

Verbal confirmation should be accompanied by an email or written confirmation, to

verify that they were the ones who sent and signed the confirmation.
 Assertions about Relevant: No
classes of transactions Procedure carried out is for occurrence. By selecting samples of the supporting
and events (Purchases) documents mentioned is not appropriate as goods or services may be delivered to
1. Completeness Corner Store but no evidence that this goods and services were actually received and
2. Cut-off even if it does, the transaction may not be recorded in the correct accounting period.

Reliable: Yes
The evidences are reliable as they are from external parties.

Weak I/C
As Corner Store has a practice of goods and services being delivered to them before
supporting documents are received or recorded, this shows that Corner Store has a poor
internal control on receiving of goods and services.

Assertions about Relevant: Yes

classes of transactions
and events (Tax) Reliable: No
Less reliable as audit manager may not be competent in the complex tax issue - lack
1. Accuracy capability.

Tutorial 4
Textbook Question 1
EMGP Q3-16

a) Information to obtain during inquiry of the predecessor(ex) auditor prior to accepting the engagement
• Information that might bear on the integrity of management
• Disagreements with management about accounting policies, auditing procedures or other similarly
significant matters
• Communications to those charged with governance regarding fraud and non-compliance with laws or
regulations by the entity
• Communications to management and those charged with governance regarding significant deficiencies in
internal control
• The predecessor auditor’s understanding about the reasons for the change of auditors

(b) The additional procedures Tish & Field should perform before accepting the engagement include the following:
• Obtain and review the financial information available
• Inquire third parties about any information concerning the integrity of the client and its management
• Consider if prospective client has any special attention or may represent unusual business or audit risk,
such as litigation or going concern issues.
 • Determine if the firm is capable of providing the desired service
• Determine if the firm has the necessary skills and knowledge of the industry
• Determine if the acceptance of the client would violate any applicable regulatory agency requirements or
the Code of Conduct

EMGP Q4-22

A business risk is a future possibility that may prevent a business from achieving a business goal. It refers to the
basic viability of a business, the question of whether a company will be able to make sufficient sales and generate
sufficient revenues to cover its operational expenses and turn a profit.

a. Business Risks (b) Effect on Acceptance Decision

1.Commercial Viability Risk New Skin may face difficulty in continuing their business,
New Skin is a start-up company providing biotech there could be management pressure to improve sales
products, they require large amounts of capital and result in material misstatement. Hence, we might not
(specialized skill sets, training, investment for likely to accept New Skin as an audit client.
specialised machines).
May face longer period of accumulated losses before Commercially viable risk→ if cannot sell well then going
gaining profit as longer period of trials is needed concern risk
before the product can be successfully developed
and is commercially viable. (R&D)

2. Lack of track record for comparison Due to lack of past records, it will be harder to audit and
New Skin, being a new company in a developing evaluate the reliability of evidence, hence harder to
industry, its reputation might not have been detect unusual trend/spot RMM. (no point of reference to
established, therefore auditors have no past compare with) risk of high MM not being detected
records/past experience as a point of reference to
tell when sales is high/low when auditing the
company hence, not very trustworthy.

3. Compliance risk Since they are new to this regulatory environment, they
New Skin, is a company in the biotech industry may not be able to fully comprehend and understand all
(subjected to extensive and strict rules and the rules and regulations required in the biotech industry
regulations), if products do not meet these as they require specialised experts. This will pose a higher
requirements, they may not get the approval to sell risk to the acceptance decision of the audit firm as they
the product and R&D and investment costs cannot might not have the professional competence and due
be recovered. care. If they are unable to sell its product due to failure to
comply with strict requirements → going concern risk

4. Competitive risk, New Skin may potentially run into the going concern risk
If the biotech industry is very competitive, and New due to overwhelming competition in the industry.
skin does not have enough effective products that
can compete with its competitors.
 5. Operational Risk due to product/technological Risk of firm management not disclosing/hiding their
failure. product failure by misstating their Financial Statements.
E.g. Blood testing machine don’t work, gives This may lead to litigation risk. (sue for product failure)
misleading results, or drugs developed are
ineffective/contaminated. Bad quality control. If operational risk is high, the integrity of management
may be compromised, thus raising Audit Risk to a high
Will lead to legal claims being made against New Skin level. Difficult to audit the effectiveness of firm’s product.
Pharma, and create adverse media attention. This
will result in lower profits due to hefty legal expenses
from this contingent(potential) liability and victim
compensation, on top of a severely tarnished
reputation.

6. Resource Risk A shortage of funds for research and development will

Start-up biotech company might not have sufficient mean slower development to launch products and lead to
tangible assets to secure financing such as loans going concerns. Auditors might face the risk of not get
from banks. Most of the capital will be invested into paid.
research and development.

7. Management Risk Any failure of partnership may pose a going concern risk
Start-up company may enter into
partnership/strategic alliances with other companies
for economies of scale.
This brings about a risk of dispute/disagreement.

Question 2 Set out the procedures that you would follow and the factors you would take into account in
deciding whether or not to accept appointment as auditors of AI.
You have recently been approached by the directors of AI Pte Ltd, who have asked your firm
to accept appointment as auditors. AI h as recently invested a significant sum of money in
developing a driverless plane, which has yet to generate significant revenues. AI had included
the development costs on its balance sheets for the previous two years as assets, but AI’s
present auditors had qualified their audit reports on the basis that they were unable to state
that the development costs would be recovered. AI’s directors tell you that they wish to
change auditors because they think that their present auditors are too incompetent and have
overcharged the audit fee. The directors suggest that you lower the audit fee by ten percent
as compared to last year’s fee. In compensation for the fee reduction, they would like you to
provide accounting and taxation services in addition to the audit. Your firm is currently the
auditor of Drones Pte Ltd, who is in a legal dispute with AI over patent issues. The directors
have asked your firm to commence the audit immediately because audited accounts are
needed by the bank in a month’s time to review the extension of overdraft facility for AI.
1. Development costs
Development cost (capitalized only if it is developed) is different from research cost (expense). If the firm is
inexperienced and is not competent with knowing if the cost should be capitalized or expensed off, they should
not take up the audit. However, if they wish to take up the audit project, they should have experienced team
members.

2. Asset
Risk of mm of having developing cost as asset, as previous auditor says its expense. Hence, they might overstate
their assets which would lead to overstated profits.

3. Present auditors had qualified their audit reports

As the firm qualified the audit report, they did not agree with the client’s financial statement.
 This suggests that the management may be uncooperative with the audit firm, heightening the risk of material
misstatement.

4. Wish to change auditors

Management will give Intimidation threat/ challenge the auditors view → as they fired the previous auditors, they
will have a higher chance of changing auditor. Communication with the previous auditor to find out why the client
changed auditor, as there may be other underlying reasons to the change not disclosed by client.

5. Suggest that you lower the audit fee by ten percent

Will be required to cut down on the extent and scope of the audit procedure → increase the risk of mm and risk
of audit failure. If don’t cut down extent of procedure then audit fee may not be able to cover costs.
Self-interest threat → don’t check further because fee is low
Intimidation threat → Letting client influence/put pressure to reduce the scope of work to do

6.Like you to provide accounting and taxation services in addition to the audit
Self-review threat → Objectivity, they are hired to audit the firm and also provide taxation, audit firm may not
have clear objective. Since client is NOT a PIE, since it is a Private Limited Company, they may be able to provide
the service depending on the type of service but safeguard is needed.
Non-PIE→ ensure that the total fee from one client is not significant → based on audit firm’s internal guidelines.
(If PIE is 10 percent)

7. Drones Pte Ltd, who is in a legal dispute with AI

When answering questions for Audit Process, use the word “may” instead of “will”
Confidentiality → Clients may be afraid that the auditors will disclose their confidential/sensitive information to
each other. Concern that auditors may act against their interest.

8. Commencement of audit immediately

Concern that may not have enough resources to start immediately. Or complete within the job in one-month
time.
Resources include manpower, documents etc.

9. Audited accounts are needed by the bank

Bank is main user of the FS (if banks are using the information to make decision, auditor will have to provide low
audit risk report)
Type of user will affect the Audit Risk
Since the bank is relying on the auditor’s expressed opinion of firm’s Financial Statements, they may sue the
auditor if material misstatements are not detected, so to recover the overdraft/loan granted, thereby raising the
litigation risk faced by the auditor.

10. Extension of overdraft facility

Pressure to show better results to convince the bank to lend → high risk of management bias (to show the
amount that the SH expects).

Question 3 Discuss the implications of the circumstances described in the audit

senior’s note; and (ii) Explain the nature of any reporting that should take place by the
audit senior. (iii) Recommend FOUR elements of an anti-money laundering
programme which audit firms such should have in place.
You are a manager responsible for the audit of Best Food Pte Ltd, an owner -managed
business which operates a chain of pubs and restaurants. This is your firm’s first year auditing
the client and the audit for the year ended 31 M arch 2016is underway. The audit senior sends
a note for your attention: ‘Best Food Pte Ltd.’s revenue is almost entirely cash -based and is
recognised at $6million in the draft financial statements. A review of the accounting records
shows that cash till receipts from customers amount to only $4million. I questioned Lucy
Lim, the financial controller about this discrepancy. She said that Mark Tan, the company’s
owner, deals with cash receipts and all journal entries relating to cash and revenue were
handled by him and no one in the company knows the nature of these entries. While auditing
cash, I noticed a payment of $2 million made by electronic transfer from the company’s bank
account to a financial institution in Nigeria. The bank statement showed that th e transfer was
authorised by Mark Tan, but no other documentation regarding the transfer was available.
When questioned about the source of cash receipts and the reason for the journal entries and
electronic transfer, Mark Tan refused to give any answers a nd became quite aggressive.
1. There is a risk of money laundering activities. Money laundering covers any activity by which the apparent
source and ownership of money representing the proceeds of crime are changed so that the money appears to
have been obtained legitimately.

3 stages of money laundering - Placement, Layering and Integration

2.Placement: Cash based business. Easy to blend funds - treating illegal proceeds as sales proceeds from normal
business activity (restaurant & pubs)

→ Ideal environment, cash from illegal sources to be placed and recorded as deposits from genuine customers.
For example, since there are no sales invoices issued upon each sale by Best Food Pte Ltd to cash-paying
restaurant/pub customers, it is easy to disguise illegal cash inflows by recording them as “Sales Revenue” in the
books, as though the money came from selling food & beverage to customers.

The company itself becomes the placement vehicle for illegal(dirty) money. The cash may or may not be stored in
the company’s bank account.

3. Layering: cash passes through complex transactions through many layers and make it difficult to trace. (point 4
and 5 → signs of layering to disguise the source of funds)

4.Layering: Bank transfer in $2milion

→without supporting documentation

5.Layering: Same 2 million was transferred out to Nigeria

→ out of ordinary course of business (not a place where they do business)

6. Integration: the money wired back into the legitimate economy

7. Suspicious matters
→ Mark responded aggressively
→ The financial controller has secrecy surrounding the transactions
→ Cash receipt, journal entries pass by Mark (CEO)

8. Careful not to tip off management (client), not to alert the client that auditor is suspicious of client’s activities
and enable client to take action that may prejudice any investigation into the situation.

9. Impact on FS- $2 million maybe material to Financial Statement as revenue is overstated which can affect true
and fair view.

10. Actions: Report to Money Laundering Reporting Office (MLRO)

(ii)
The audit senior should report the situation in an internal report to the audit firm’s Money Laundering Reporting
Officer (MLRO).

Audit firms should have a single reference point, i.e. the MLRO, within the organisation to whom all employees are
instructed to promptly refer to for transactions suspected of being connected with money laundering. The MLRO
is a nominated officer who is responsible for receiving and evaluating reports of suspected money laundering from
colleagues within the firm, and making a decision as to whether further enquiries are required and if necessary,
making reports to the appropriate external body.

The MLRO will determine whether a report to the STRO (suspicious transaction reporting office) is necessary.
Hence, the audit senior should consult with the MLRO first to determine the next appropriate steps to take.

(iii)
Reporting Procedures
Audit firms should appoint a MLRO (Money Laundering Reporting Officer) who will determine whether to report
the case to the STRO (Suspicious Transaction Reporting Office) with the CAD (Commercial Affairs Development)

Ongoing training
Audit firms should establish ongoing training programme and take appropriate steps to ensure all staffs know
their responsibilities and know the new developments through regular training.

Test them after 6 months after the training have ended to test them on whether did, they incorporate into their
procedures.

Know Your Client (KYC)

Professional firms shall identify and verify the client’s identity to know and understand what the company is
doing/operating.
• Know the names and positions of each of the people in the company

Maintenance of records
Records of client identification procedures, and of all transaction relevant to audit clients, for example, the
receipt of cash for services performed, should be maintained. This is important to ensure that the audit firm does
not inadvertently become party to a transaction involving money laundering.
Tutorial 5
Textbook Question 1
Q4-17
When planning a financial statement audit, an auditor must understand audit risk and its components. The firm of
Pack & Peck evaluates the risk of material mistatement (RMM) by disaggregating RMM into its two components:
inherent risk and control risk.
Required:
For each illustration, select the component of audit risk that is most directly illustrated. The components of audit risk
may be used once, more than once or not at all.
Components of Audit Risk:
a. Control Riske
b. Detection Risk
c. Inherent Risk
Illustration Component of Audit Risk
1. A client fails to discover employee fraud on Control Risk
a timely basis because bank accounts are
not reconciled monthly.
2. Cash is more susceptible to theft than an Inherent Risk
inventory of coal. (cash is easier to steal)
3. Confirmation of receivables by an auditor Detection risk
fails to detect a material misstatement.
4. Disbursements have occurred without Control Risk (control should be in place to ensure
proper approval. every payment is properly approved.)
5. There is inadequate segregation of duties. Control Risk (segregation of duties implies that it
should be in place already)
6. A necessary substantive audit procedure is Detection Risk
omitted.
7. Notes receivable are susceptible to material Inherent risk
misstatements, assuming there are no
related internal controls.
8. Technological developments make a major Inherent risk
product obsolete.
9. The client is very close to violating debt Inherent risk
covenants. → didn’t pay on time
10. XYZ Company, a client, lacks sufficient Inherent risk
working capital to continue operations.
Q4-18

A.
Inherent risk – Firstly, Ivan Johnson has majority control of the stock and dominates the decision making in the
company. This factor will lead to a higher inherent risk due to the absence of reviewing of important decisions. He
may be making decisions that are in his own personal interest. Thus, it may result in actions taken that are not in
the best interest of the company or its minority stockholders.

Control risk - Johnson is a rapidly expanding company, there is a need for delegation of controls and decision making
such performance review and monitoring of controls. Risk that current controls are not adequate enough to support
expansion.

Therefore, detection risk has to be low for audit risk to be low and acceptable.

B.
Inherent risk –
1. Obsolescence of technology cause short shelf-life of the product, the current technology can be easily replaced
reducing the shelf-life of the product, hence company may have to sell inventory at a discount and hence, NRV
may fall below cost, resulting inventory to be overstated.

2. Management would be under pressure to show financial results

They are in a competitive industry and they are slightly behind the industry leaders hence, pressure on
management to show results for the company’s financial performance and position.
They are in a competitive industry can lead to downward pressure of sales such as price cutting (higher risk of
overstating the sales)

Therefore, detection risk has to be low for audit risk to be low and acceptable.

C.
Inherent risk –

1. Frequent disagreement
Different views relating to for loan loss reserves (similar to provision of doubtful debt) - higher risk that loan loss
reserves may be highly valued, posing a very high risk of MM.

2. History of Misstatements in the loan-loss reserves

History of misstatements (prior years) in recording of sales indicate low controls, if history of loan losses, indicates
a judgemental problem (management bias)
 3. Previous audit show history of misstatement judgmental issues → management bias

4. Audit firm has been the auditor for 2 years

New audit client, affecting DR as they are unfamiliar with the client and may not perform enough procedures

Therefore, detection risk has to be low for audit risk to be low and acceptable.

Q4-23
Business Risks → Inherent Risk (MBA)

Business
1. Cashflow - Car Proof is facing cash flow problems, Car Proof has incurred substantial losses during the past
three fiscal years. This might lead to going concern issue

2. Nature of Industry - the car industry requires company to invest lots of money into developing a new product,
as such their existing facilities were insufficient to support operation resulting in high going concern risk.

3. Most of the products are matured lines, this will limit sales growth, thus the success of the company will
depend on the success of new products.

Accounting
1. Lawsuit - the company wants to record the estimated gain on settlement of $4mil but there is no legal
correspondence to date. Gain overstated (Occurrence) and receivables to be overstated (existence)

2. No amortization of subcontract cost - The deferred development cost of $2million incurred has not be
amortized. The company setting the estimated amortization to a period of 20 years - may not be a realistic
estimate. This could affect the accuracy, valuation and allocation assertion.

3.Bank loan - Loan is secured by floating charge over all corporate asset. Risk that company may overstate the
assets to secure more loans. (when taking up loan, there will be a loan covenant, (Loan covenant - a KPI on the
borrowers stating T&C that the borrower needs to meet). If they did not meet the T&C stated in the covenant,
they may face pressure to comply with the terms and condition, making fictitious transactions.

Addition info: Loan covenants (It is to protect the lender): terms and conditions that a borrower need to comply
with. E.g. to maintain a certain level of liquidity ratio (debt equity ratio - less than 1, current ratio more than 2)
Management face pressure to comply with the terms and conditions.

4. Accounting estimates and valuation - The previous auditors disagree with Car Proof valuation of deferred
development cost

Management
1. Management is pressured to develop the new product as the selling price for the new product is more
desirable. However, they are unable to meet the production capacity of the new product. Limiting sales growth as
success of company is dependent on the success of the new product.
Question 2

a. Industry related risk

- reliance on weather conditions as cannot fly during bad weather which will lead to the company incurring losses.

- High reliance on airplanes which means airplanes would need technical servicing often, this incurs high repair
and maintenance costs for the company.

- Fuel price risk: Sudden significant fluctuations not covered by revenue

- Reliance on external agents on the sale of extra tickets will lead to double booking hence will result in an
overstatement of sales.

- Regulations - if any countries impose regulations to prevent airline from flying into the country (Political factor)

- Competition from budget airlines

b.
RMM How this affects FS

1. Unable to receive supply of Company may have recorded airplanes as their PPE, but the assets may not
airplanes due to technical be received on time, hence causing the assets to be overstated. Assets may
difficulties not exist at financial year end.
High inherent risk → high RMM at assertion level → existence

2. Applied for loan but yet to Company seems to be in need of capital. As the company’s profitability has
receive reply. What if loan is been on a declining trend, the loan may not get approved. Therefore, they
not approved? may have incentive to report FS in a favourable light to get loan approval. If
company do not get the funds required to purchase the planes, they might
be facing risks of not meeting the contract obligations with supplier,
therefore facing penalties for breach of contract and even cash flow
problem. This poses a going concern risk.
High inherent risk → High RMM at assertion level → existence,
presentation (disclosure)

3. Some of the receivables Management are pressured as they were unable to collect their
have been having difficulties in receivables, hence they have to extend their credit terms.
making payment due to Higher bad debts → Affecting cash flows. AR may be overstated due to bad
difficult trading conditions debt risk. The company is unable to accurately estimate and provide
provision to collect receivables. Hence causing the Account receivables to
be overstated.
High inherent risk → High RMM at assertion level → AVA

4. “The company has spent an $20 million can be capitalised as an asset if it can enhance the asset (e.g.
estimated $20m on extend its useful life) which satisfy FRS 16 criteria. (Refer to FRS 16)
refurbishing their existing High inherent risk → High RMM at assertion level → classification
planes”

5. “Tickets have been booked This arises from the use of a technological booking system in their normal
and paid online but Jet Air Ltd business transactions. An error in the system has occurred which caused
has no record of them and this overbooking. They do not have any back up documentation/system to
hence has sold the seat to ensure that overbooking does not occur thus this shows a lack of internal
another customer.” controls
High control and inherent risk → High RMM at assertion level →
occurrence

6. “Management will risk losing The management is inclined to produce strong financial result through the
their bonuses” Financial statements in order to obtain their bonuses and they do not wish
to risk losing it.
High inherent risk → High RMM at FS level
Question 3

RMM Assertion

(I) The recording of sales transaction even though the customer refuse A/R - Existence
to pay is a form of RMM. The performance obligation is not met as Sales - Occurrence
there is no acceptance by the customer This will result in overall profits
and sales revenue to be overstated.

(ii) Since Never Pay Pte Ltd became Starfish biggest customer there is A/R - Existence
RMM as the default payment of $700,000 will overstate starfish's Sales - Occurrence
revenues and may also result in potential liquidation. No confirmation
reply was received hence the A/R may be from a fictitious customer.
Potential RMM is Accounts receivable.

(iii) Lack of manpower to sort out invoices, resulted in supplier’s invoices A/P - Completeness
not being processed in time for the year-end closing. The relevant Purchases - Completeness (Did
accounts affected will be purchases, Accounts payable. not record purchases) / Cut-off
(Fail to record the purchase
before financial year end.)