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Question 1 (30 marks)
Case: New Territories Light and Power Ltd.
You are the manager in charge of the audit of a newly obtained client, New Territories Light and Power Ltd. (NT), for the year ended 31 December 2014. NT has entered into a Scheme of Control Agreement (SCA) with the Hong Kong Government. The SCAs provide the framework for the Government to regulate the power companies and monitor their corporate affairs to protect the interests of consumers. Pursuant to the SCAs, the power companies are required to seek the approval of the Executive Council for certain aspects of their development plans, including projected basic tariff levels, and the agreement of Government to their annual tariff adjustments. Meanwhile, technical, environmental and financial performances of the power companies are subject to annual auditing review conducted jointly by the Government and the companies. As NT is a publicly traded company, the audited financial statements must be lodged with the HK Exchange and Clearing Ltd.
NT is considerably more profitable than many of its competitors, largely due to its extensive investment in information technologies used in its energy distribution and other key business processes. Recent growth into rural markets, however, has placed some strain on 2014 operations. Additionally, NT expanded its investments into speculative markets and is also making greater use of derivative and hedging transactions to mitigate some of its investment risks. Because of the complexities of the underlying accounting associated with these activities, NT hired several highly experienced accountants within its financial reporting team. Internal audit, which has direct reporting responsibility to the audit committee, is also actively involved in reviewing key accounting assumptions and estimates on a quarterly basis.
Your discussion with the predecessor auditor revealed that the client has experienced some difficulties in correctly tracking the existing property, plant and equipment items. This largely involves equipment located at its multiple energy production facilities.
You plan to staff the audit engagement with several members of your CPA firm who have experience in auditing energy and public companies. The extent of partner review of key accounts will be extensive.
(a) Based on the above information, identify seven factors that affect the risk of material misstatements for the audit of 31 December 2014 financial statements of New Territories Light and Power Ltd. Indicate whether the factor increases or decreases the risk of material misstatements. Also, identify which audit risk component is affected by the factor. Use the format below.
Factor Effect on the Risk of Audit risk Material Misstatement Component
(b) Based on the above information, identify two factors that may affect the planned detection risk.(4 marks)
(c) In general, discuss the reasons for an increased or decreased planned detection risk.(5 marks)
Question 2 (25 marks)
Learning Solutions Ltd. is in the business of providing educational technological products to learning institutions and businesses worldwide and is listed on the Hong Kong Stock Exchange. However, recently, accounting scandals and fraud allegations have sent the company’s stock price crashing and forced the firm to seek bankruptcy protection. The following selected information is related to Learning Solutions Ltd.’s sales and accounts receivable:
1. Consolidated revenue increased 184% from 2013 fiscal year to the 2014 fiscal year.
Revenue in South Korea, which has a reputation as a difficult market for foreign companies to enter, increased from $100,000 in the first quarter of 2013 to approximately $50 million in the first quarter of 2014.
In the second quarter of 2014, sales grew by 104% but accounts receivable grew by 128%.
Average days outstanding increased from 138 days in 2013 to 160 days for the six-month period ended 30 June 2014.
(a) Based on the above information, which assertion(s) for sales should the auditor be most concerned with? Discuss why. (2 marks)
(b) Based on the above information, which assertion(s) for accounts receivable should the auditor be most concerned with? Discuss why. (4 marks)
(c) What audit evidence should the auditor gather to verify the assertion(s) for sales and accounts receivable? Be specific as to how each type of evidence relates to the assertions you mentioned in parts (a) & (b) of this question.(9 marks)
(d) Discuss five factors auditors should consider in planning the mix of audit procedures required (ie tests of controls and substantive procedures) in order to gather sufficient and appropriate audit evidence. (10 marks)
Question 3 (25 marks)
The following are misstatements that have occurred in Pak and Save Foods Ltd., a retail and wholesale grocery company.
(1) On the last day of the year, a truckload of beef was set aside for shipment but was not shipped. Since it was still on hand it was included as inventory. The shipping document was dated the last day of the year so it was also included as a current year sale.
(2) The incorrect price was used on sales invoices for billing shipments to customers because the wrong price was entered into the computer master file of prices.
(2) A supplier invoice was paid even though no merchandise was ever received. The accounts payable software application does not require the input of a valid receiving report number before payment can be made.
(4) Employees in the receiving department took some beef home for their personal use. When a shipment of meat was received, the receiving department filled out a receiving report and forwarded it to the accounting department for the amount of goods actually received. At that time, the beef were put in an employee’s pickup truck rather than in the storage freezer.
(5) An accounts payable clerk processed payments to himself by adding a fictitious supplier address to the approved supplier master file.
(6) During the physical count of inventory of the retail store, one count person wrote down the wrong description of several products and miscounted the quantity.
(7) A salesperson sold an entire carload of lamb at a price below cost because she did not know the cost of the lamb had increased in the past week.
(8) A supplier’s invoice was paid twice for the same shipment. The second payment arose because the supplier sent a duplicate copy of the original 2 weeks after the payment was due.
(a) For each misstatement, identify the management assertion that has not been met. (9 marks)
(b) For each misstatement, suggest an internal control to correct the deficiency.(16 marks)
Use the format below.
Management assertion that has not been met
Internal control to correct the deficiency
Management assertion that has not been met
Internal control to correct the deficiency
Question 4 (20 marks)
Give two examples of errors or fraud that would misstate financial statements to affect the accounts as follows, taking each case independently. (Note: “overstate” means the account has a higher value than would be appropriate under GAAP and “understate” means it has a lower value.)
(a) Overstate one asset; understate another asset.
(b) Overstate an asset, overstate revenue.
(c) Overstate an asset, understate an expense.
(d) Overstate a liability, overstate an expense.
(e) Understate an asset; overstate an expense.
(4 marks each)
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