Solved by verified expert :Audit
and Personal Tax – Audit Assignment
Case Study
Ruthies is a fast expanding firm of chartered
certified accountants with a growing number of audit
clients.
In April 2011 the firm was approached by the directors of Jonp Limited
and asked to act as the company’s auditors. Ruthies’ partners were surprised by the
approach given that Jonp Limited is a well established company, with a new financial
director (a young very recently qualified accountant – and the son of the
managing director), apparently sound management and complex, sophisticated
computer- based administrative and accounting systems. Further, they were aware that its auditors had
been in place for quite a number of years. Typically, over recent years the
company has reported annual pre-tax profits in the region of £2 million. Notwithstanding
their surprise, having carried out their
normal procedures prior to deciding as
to whether to accept the audit appointment, after giving due consideration to
all relevant matters the partners of Ruthies
decided to accept the audit engagement and the firm was duly appointed.
The directors of the company own 70 per cent of the share capital of
Jonp Limited and the balance is owned by an unconnected individual investor –
who in addition to owning shares in the company, has provided secured loan
funds to the company at (better than bank) very competitive interest rate
terms. The investor currently has a loan of £500,000 outstanding from the
company which is due for repayment ‘ on demand’ (i.e. at any time – as
soon as requested by the investor).
Jonp Limited sells high quality personal
computers, television sets, digital versatile disc (dvd) players and a very
broad range of associated accessories from eighteen retail stores located in
separate towns across the United Kingdom. Each store also has a large workshop,
from where large teams of engineers repair high quantities of personal
computers, television sets and dvd players, brought in and collected after
repair, by customers. The customers pay for the repair works, by cash, debit
card or credit card on collection of their property. There are also separate teams of engineers
based at each store employed to install television aerials supplied by the
company. All engineers are paid weekly, receiving a basic hourly rate of pay
and regular high bonus payments based on a very complex productivity scheme.
The audit engagement partner in charge of the audit of the financial
statements of Jonp Limited for the year ending 31 December 2011 is Mr Rivers
and he has been informed by the directors of the company that they have
received an offer from a third party to buy all of the shares in the company.
The final offer price will depend upon the company’s trading results for the
current financial year. It transpires that the directors of Jonp Limited, have,
for some time, been looking to sell the company and have been taking measures
to increase interest from potential suitors to purchase. These measures included the undertaking of an
extensive repair, renovation and improvement programme of works since February
2011 on its stores and workshop premises.
In January 2011 , whilst
working on the installation of a
television aerial at a customer’ house, an engineer suffered
very serious injuries in a fall from the roof – a consequence of which is that
he is now unable to work and is
permanently retired. After taking legal
advice the ex – employee is now threatening to sue the company for ‘ health and
safety’ negligence unless it settles his claim against it for £320,000. The
company has denied liability and is contesting the claim on the basis that
in the directors’ opinion the employee would not have fallen if he had followed the company’s health and
safety procedures, when installing the aerial. On this basis
the company has not made any provision in its annual
financial statements for any
payment to be made to the employee. The company has copies on file of all of
the extensive correspondence including that between the employees’ solicitors
and its own solicitors. Mr Rivers has
also been informed
( verbally by the managing
director ) that in the event of a successful claim against the Jonp Limited,
its health and safety insurance policy would not
cover any liability as at the
time of the accident, due to an oversight
by the company in not renewing
cover on a timely basis , the
company was not insured in this regard at the time of the
accident .
Mr Rivers decided that the
audit team will, as required, adopt a risk- based strategy to the final audit
and he has assessed the inherent risk associated with the audit as being
‘high’. When enquiring into the company’s system of internal control he
ascertained that during the months of June and July 2011 the manager and
assistant manager at one of the company’s larger stores had colluded in
perpetrating a fraud against the company by misappropriating cash payments made
by customers for repair works carried out. Both employees were subsequently
dismissed from their employment with the company. Investigation revealed that they
had simply over-ridden established internal controls to ensure that the sales
transactions represented by these repairs were not recorded in the company’s
accounting records. Notwithstanding this incident, having ascertained and
evaluated the internal control of the company Mr Rivers has assessed the
associated control risk as being ‘low’. Now, in December 2011, he is preparing
the strategy and detailed audit planning for the audit engagement.
In conversations with Mr
Rivers about auditors and the external audit function generally, Charles Candy
– the Financial Director of Jonp Limited, expressed the following views:
“It seems obvious that an auditor
who possesses the
personal attribute of good
professional judgement will
be a good auditor”
“We spend a lot of time and
resources investing in the internal
control of the company. Therefore, I don’t see the point on your wanting to focus
so much time and resources on it. In my view, given the obvious competence and
integrity of our management team, your firm’s approach to the audit should be to just accept that there are no deficiencies in
our internal control and focus simply on
carrying out substantive procedures –
thus saving us a lot of money in audit
fees “.
REQUIRED
a) Identify TEN significant
matters that you would expect to have influenced Mr Rivers to
assess as ‘high,’ the
inherent risk associated with the audit of the financial statement of Jonp
Limited. You should explain the audit concern associated with each matter.
(500
words)
b) Explain the
audit procedures that your firm should carry out to obtain
assurance
about the amount of the provision if any that should be
included in the company’s financial
statements, in connection
with the ex-employee’s accident.
(100 words)
c) Describe
SIX typical control activities that you would expect Mr Rivers to have
found
when ascertaining the system employed for
repairs to personal computers, television sets
and dvd players by Jonp Limited. Such controls could cover for example physical security of
items held for repair, job costing
or completeness of recording in the company’s accounting
records. You should explain the
objective of each control procedure described.
(180 words)
d) Explain why testing by the auditor for
completeness of income in a company such as
Jonp
Limited would be considered to be more difficult and complex than testing for
completeness
of income in a similarly well controlled single site manufacturing company
selling
goods to a relatively small number of
wholesalers on credit terms.
(120 words)
e) Discuss the validity of Charles Candy’s comment
about the determinant of a good
auditor
(500
woords)
f) Discuss the validity of Charles
Candy’s stated views about the
how your firm should approach
its audit
of the financial statements of Jonp Limited.
(500 words)
