Question 1

Part A:

The audit risk model has become the commonly used basis for audit planning. The following are independent situations that could have an effect on various components of the audit risk model.

For each situation, identify the element(s) of the audit risk model (that is, audit risk, inherent risk, control risk, and detection risk) that is (are) most likely to be directly affected and the nature of the change in risk levels (increase or decrease) relative to a typical audit. Explain your reasoning in detail.

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a.     A company provides all customers with the option to return unused goods within two weeks of the purchase.

b.     In the current year, the company began performing credit checks for all new customers. The customers’ credit ratings were used to determine credit limits for the customers.

c.      A client’s sales team is primarily compensated on a commission basis. Commissions are determined on a percentage-of-sales basis.

d.     All cheques greater than a pre-determined limit require the signature of the controller and the chief financial officer.

e.     In order to raise capital, in the current year the owner-manager of a business sold 20% of the common shares to a private-equity investor. The owner will remain actively involved in the business. The private-equity investor will not actively partake in the daily management of the business.

f.      An auditor tests a control and observes several compliance deviations.

g.     In the past two prior-year audits, the auditor has identified several material overstatements in inventory.

Part B:

For each of the following independent  situations, state whether the CGA has violated generally accepted auditing standards and/or the CGA-Canada Code of Ethical Principles and Rules of Conduct or Independence Standard and explain your reasoning in detail.

a.     Emily, CGA, owns a material amount of units in a mutual fund that owns stock in Emily’s largest audit client. Reading the mutual fund’s most recent financial report, Emily learned that the mutual fund significantly increased its holdings in her client.

b.     Martha, CGA, has a practice with two departments. One department performs assurance services and the other performs bookkeeping services. One of her publicly accountable audit clients lost its controller and the bookkeeping department provided controllership services for 30 days while the company searched for a new controller. As this was an emergency, it  was necessary for Martha’s firm to provide the service because it has an intimate knowledge of the client’s system.

c.      In an effort to expand his business, Mathew, CGA, places an advertisement in the business section of the local newspaper listing specific services he performs and his rate for performing each type of service, some of which are available for a fixed fee and others for an hourly fee, which was also stated in the advertisement.

d.     Howard, CGA, discovered, during the audit of his client Ignoble Enterprises Inc., that the company had failed to include a significant amount of income on last year’s corporate income tax return. Howard suggested to the controller that he submit an amended return. When the controller refused, Howard resigned from the engagement. Howard later received a letter from the successor auditor asking if Howard was aware of any circumstances that they should be aware of prior to accepting Ignoble as a client. Howard replied by letter and informed the successor auditor that Ignoble’s management failed to adjust income tax returns containing significant material errors.

e.     Emma, CGA and auditor for Nestco (a public company), recommends that the company improve its internal controls and accepts a 90-day engagement to design and implement new controls, and to train company staff on them.

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f.      Harry, a CGA student, is currently employed by a CGA firm in public practice. He accepts a 15% discount on purchases from an audit client. Harry believes that he has not violated the Rules of Conduct because he is not yet a CGA member and the discount is at the same percentage that is available to the client’s own staff members.



Question 2

The purpose of substantive testing is to verify the assertions made by management in the financial statements. Consider the following unrelated audit tests, which a CGA performed for the audit of the financial statements of a client with a fiscal year end of December 31, 2011.

Required

For each of the six audit procedures listed below, identify the primary management assertion being tested and the account balance being verified, name the specific audit procedure being used, and state the quality of the audit evidence obtained (high, moderate, or low), explaining why the evidence is the quality level you specify. Organize your answer with these headings and provide detailed answers:

Management assertion

and account balance

Audit procedure

Quality of audit

evidence

a.     Calculated the ratio for sales commission expense to sales as a test of sales commission. (2 marks)

b.     Reviewed the accounts receivable balances with the credit manager to discuss collectability. (2 marks)

c.      Obtained a letter from the client’s lawyer stating that they are not aware of any existing lawsuits filed against your client. (2 marks)

d.     Examined a piece of equipment to make sure that the acquisition of the equipment took place and is operating. (2 marks)

e.     Recalculated depreciation for each category of property, plant and equipment as at December 31, 2011. (2 marks)

f.      Examined and counted Canadian government bond certificates held as investments as of December 31, 2011. (2 marks)



 

Question 3

The following are independent statements concerning certain auditing issues.

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Required

Indicate whether you agree or disagree with each statement, and explain your reasoning in detail.

a.     Each of the following changes (considered independently and holding other things constant) can be expected to decrease the level of detection risk associated with the auditor’s substantive tests:

1.     decreasing materiality

2.     increasing inherent risk

3.     decreasing audit risk

b.     An auditor was appointed to the audit of BID Inc. (BID) subsequent to BID’s year-end date. BID is in the business of providing IT consulting services and is also a computer equipment reseller. BID only orders inventory from the manufacturer once a customer has placed an order. This allows for BID to have low levels of inventory. As a result of being appointed to the audit subsequent to year end, the auditor was unable to attend the year-end inventory count and could not obtain sufficient and appropriate audit evidence for the inventory balance. In this circumstance the auditor should issue a qualified opinion due to a scope limitation and the audit report should set out the nature of the qualification in the auditor’s responsibility paragraphs.

c.      When the auditor’s preliminary assessment of control risk is that the control risk is low to medium and the auditor plans to place some reliance on the operating effectiveness of the controls to reduce the amount of substantive testing, the sample size required in testing the effectiveness of the controls should be larger since control risk is lower.

d.     Auditors perform analytical procedures on the draft financial statements at the planning stage of the audit looking for relationships that do not make sense, as these may indicate problem areas where there may be material misstatements.

e.     In audit and review engagements, an assessment of the CGA’s independence from the entity is required, whereas in compilation engagements the assessment is not required.

f.      The auditor will decide on the nature, extent, and timing of the audit evidence to be obtained and evaluated. An auditor must obtain the best available evidence with the consideration of cost.

g.     The auditor, in an audit using a combined approach, will rely on the client’s internal controls. It is the auditor’s responsibility to develop and implement effective controls.

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