SECTION A – CASE QUESTIONS (Total 50 marks)

Answer ALL of the following questions. Marks will be awarded for logical argumentation and
appropriate presentation of the answers.

CASE

BLINK Limited (also known as BLINK) is a one stop online store for fashion and footwear.
Its customers are mainly Asian. To meet the increasing customer demand, BLINK has a
worldwide network of suppliers which allows BLINK to provide a wide range of international
brands of clothing and shoes. BLINK promotes online shopping with full protection for its
customers.

You are an audit manager of a CPA firm in Hong Kong. Your friend, Sam, has joined BLINK
one month ago acting as its Chief Financial Officer (“CFO”). BLINK’s auditor (who is a sole
proprietorship) is Sam’s wife who tendered her resignation as auditor when Sam joined
BLINK. Sam approaches you and your firm to fill the casual vacancy to act as BLINK’s
auditor. The following information is provided by Sam.

BLINK’s group structure

BLINK is incorporated in Hong Kong and is the holding company of its subsidiaries. BLINK
and its subsidiaries are hereafter collectively referred to as the “BLINK group”.

BLINK has four wholly-owned subsidiaries namely Sub 1, Sub 2, Sub 3 and Sub 4 each of
which has the same year end date. Sub 1 is incorporated in Hong Kong and is principally
engaged in online sales through BLINK’s website. Sub 2 is incorporated and operated in
Vietnam and is responsible for the purchases of clothes and shoes for the BLINK group.
Sub 3 is incorporated in Hong Kong and is responsible for financing the working capital of the
entire BLINK group’s operation. Sub 4 is incorporated in Hong Kong and has been dormant
since its incorporation. Except for Sub 2, whose auditor is a local registered CPA firm
located at Vietnam, all the other subsidiaries are audited by the holding company’s auditor.

Intra-group transactions

BLINK has several types of intra-group transactions which were conducted among the group
companies within the BLINK group. Sub 2 sold goods to Sub 1 at prices comparable to
market prices. Sub 3 has a significant amount of short-term bank loan which is used to
provide operating funds for the BLINK group. Sub 3 charges interest to other group
companies at the prevailing market interest rate. All the intra-group transactions will be
eliminated when the consolidated financial statements of BLINK are prepared.

Module C (December 2016 Session) Page 1 of 9

Analysis of the significance of the group companies
(after elimination of intra-group transactions)

Contribution
Contribution Contribution to to group Contribution Contribution
to group group cost and profit for the to group net to group total
revenue expenses year assets liabilities
% % % % %
BLINK - 5 - - -
Sub 1 100 5 90 80 5
Sub 2 - 85 5 15 30
Sub 3 - 5 5 5 65
Sub 4 - - - - -
Total 100 100 100 100 100

Information obtained from BLINK’s website

Simple and Safe Shopping – Once the customers have picked out items and added them to
the shopping cart, the customers can choose between the various secure payment options.
Payment can be simply made by credit card (Visa or Master Card) or PayPal. After an order
is successfully placed, the customers are informed of the current status of their order.
Customers can also reach out to BLINK’s friendly Customer Service team to get updates on
their order status.

Fast Shipping – The customers call it “flash shipping” – as BLINK usually ships out orders the
same day!

Free Shipping – BLINK is proud to provide FREE SHIPPING on all orders above HK$100
(after discounts and vouchers have been applied). Orders under HK$100 will be subjected
to a shipping fee of HK$50.

90-Days No Questions Asked Free Return Available – BLINK offers a 90 day period from the
time of receipt for returning its customers’ orders and for a full refund.

Product Range – BLINK’s large collection of apparel, shoes, sportswear and fashion
accessories boasts outstanding styles and will realign the customers with the best of current
trends.

Appointment of auditor

After further discussions with Sam, your firm has accepted the appointment as the auditor of
BLINK to audit its consolidated financial statements for the year ended 30 June 2016.

Module C (December 2016 Session) Page 2 of 9

Question 1 (12 marks – approximately 22 minutes)

(a) Evaluate, with reference to the relevant ethical requirements, whether it is

appropriate (i) for Sam’s wife to resign as the auditor of BLINK; and (ii) for your
firm to accept the appointment as the auditor of BLINK in view of your
relationship with Sam, the CFO of BLINK.
(8 marks)

(b) In view of Sub 2’s foreign operations, explain why significant risk of material
misstatements may exist in BLINK’s consolidated financial statements?
(4 marks)

Question 2 (15 marks – approximately 27 minutes)

(a) Define significant component and explain why it is important to a group audit.
(3 marks)

(b) Evaluate each of the subsidiaries in the BLINK group as to whether it is a

significant component to BLINK or not.
(12 marks)

Question 3 (13 marks – approximately 23 minutes)

You are going to send a group audit instruction to the component auditor of Sub 2. Since the
purchase transactions conducted by Sub 2 are significant to the BLINK group, you want to
include an audit plan in the instruction which sets out the expected audit procedures of the
purchase transactions to be performed by the component auditor at the year-end.

Required:

Prepare an audit plan comprising the year-end substantive audit procedures to test the
following assertions of Sub 2’s purchase transactions:

(a) Occurrence and completeness; and (7 marks)

(b) Cut-off. (6 marks)

Module C (December 2016 Session) Page 3 of 9

Question 4 (10 marks – approximately 18 minutes)

You realise that BLINK introduces a “90-Days No Questions Asked Free Return Available”
policy to enhance customers’ protection. As BLINK is required to issue its consolidated
financial statements within 60 days after the year end date, it is not possible for the
management to obtain the actual sales return amount before then. Accordingly,
management will estimate a provision amount for sales return based on a percentage
representing the previous five years’ actual return rate applied to the revenue amount of the
BLINK group for the year when preparing BLINK’s consolidated financial statements.

Required:

(a) Explain why the risk of material misstatement increases when accounting
estimates are involved.
(5 marks)

(b) Propose audit procedures that you will perform on BLINK’s sales return
provision.
(5 marks)

* * * * * * * *

Module C (December 2016 Session) Page 4 of 9

End of Section A
SECTION B – ESSAY / SHORT QUESTIONS (Total 50 marks)
Answer ALL of the following questions. Marks will be awarded for logical argumentation and
appropriate presentation of the answers.

Question 5 (9 marks – approximately 16 minutes)

Mini Limited is a company incorporated in Hong Kong and is a subsidiary of Giant Holdings
Company Limited (“Giant”) which is a listed company in France. Mini Limited is the cost
centre of Giant in Asia which mainly provides administrative and finance support to Giant’s
other subsidiaries in Asia. Mini Limited has only 3 staff including the general manager of the
Asia operation, the financial controller and a clerk. The accounting software used by Mini
Limited for daily book-keeping is “Easydone” which is a simple packaged software with no
customization function. All 3 staff of Mini Limited edit and post access in “Easydone” and
they share the same user ID and password. All accounting vouchers are kept in paper
format. Both the preparers and reviewer are required to sign on the paper vouchers.

Required:

(a) Assume you are the auditor of Mini Limited, identify and explain two likely
causes of material misstatements in the financial statements in terms of the
segregation of duties and control over system access in relation to the audit of
its Hong Kong statutory financial statements.
(4 marks)

(b) In respect of the small operation scale of Mini Limited, discuss and explain
whether you would adopt a combined testing approach of substantive
procedures and tests of controls.
(2 marks)

(c) In respect of Mini Limited’s computer environment, discuss and explain whether
you would test the IT controls of Mini Limited.
(3 marks)

Module C (December 2016 Session) Page 6 of 9

Question 6 (10 marks – approximately 18 minutes)

The Code on Corporate Governance Practices (the “HK Code”) published by the Hong Kong
Stock Exchange contains a combination of broad principles, specific code provisions and
recommended best practices.

Company A is a garment manufacturing company and plans for an initial public offering (“IPO”)
in the coming year. Company A is primarily owned by Mr Lee and Mr Chung who are the
Chairman and Chief Executive Director (“CEO”) of Company A respectively. You are the
auditor of Company A. During the audit planning meeting, Mr Lee and Mr Chung seek your
advice as to how Company A should comply with the HK Code to prepare Company A to be
listed on the Hong Kong Stock Exchange.

Company A’s board of directors consists of seven members including Mr Lee, Mr Chung and
one independent non-executive director that meets on a regular basis to discuss key
business matters. Company A’s board of directors consists of members who have extensive
experience in the textiles industry and strong finance backgrounds.

Company A has an internal audit team but has yet to set up any audit committee or any other
committees to support the board. The head of the internal audit team reports directly to
Mr Lee. Company A’s company secretary is a third party service provider who provides
Mr Lee and Mr Chung with the latest corporate governance information on a regular basis.

The prior year audit evidenced that Company A has set a good practice at the top and
introduced a clear business code of conduct to all of its employees. The tests of controls
also indicated that Company A’s key controls over financial reporting were effective.

Required:

(a) Explain the current approach required by the Hong Kong Stock Exchange for a
listed company in Hong Kong when applying the HK Code.
(2 marks)

(b) Identify elements which indicate that Company A is in compliance with the HK
Code.
(4 marks)

(c) Recommend how Company A can improve its corporate governance for the
preparation of the IPO.
(4 marks)

Module C (December 2016 Session) Page 7 of 9

Question 7 (16 marks – approximately 29 minutes)

Rent Smart Limited (“R Smart”) is a leading service company in Hong Kong providing
portable sanitation equipment and cleaning services. It supplies portable restrooms which
are widely used at construction sites, special events or corporate functions. You are the
audit engagement senior and are new to the audit engagement of R Smart. You have been
asked by your audit engagement manager to plan the year end audit procedures for the fixed
assets of R Smart. You studied the prior year’s audit work papers and inquired the finance
manager of R Smart. Your findings are summarised below:

 Over 70% of R Smart’s total assets are sanitation equipment.

 R Smart’s sanitation equipment (i.e. over 300 portable restrooms and pumping
systems) are all rented out most of the time. These items of sanitation equipment are
usually held at the customers’ premises and R Smart keeps a good record of the
locations of these items of sanitation equipment.

 R Smart has been very profitable and received very good comments from its
customers on service quality.

 R Smart’s office and warehouse are located in the New Territories. R Smart has a
team responsible for equipment cleaning and maintenance.

 During the year, the management of R Smart considered the increasing demand of the
toiletry service and purchased 100 more portable restrooms and spent a significant
amount on 100 existing portable restrooms to improve their facilities and design.

 Since most parts of the sanitation equipment are very durable, R Smart adopts a
depreciation policy that is comparable to other industry players. The sanitation
equipment is depreciated over 10 years.

Required:

In response to the facts given above,

(a) Assess the risks of material misstatements of fixed assets in terms of the
existence and valuation assertions and explain your views.
(4 marks)

(b) Propose the relevant audit procedures in response to the risks identified in
Question 7(a) over the existence assertion.
(6 marks)

(c) List the factors that should be considered when planning the fixed asset count
at year end.
(6 marks)

Module C (December 2016 Session) Page 8 of 9

Question 8 (15 marks – approximately 27 minutes)

Company A is a garment manufacturing company and owns 100% equity interests of

Company B and Company C. Company B and Company C are both yarn manufacturing
companies and each pay a monthly management fee of HK$100,000 to Company A for the
administrative and financial services provided by Company A. During the year, Company A
purchased a large volume of yarns from Company B and other external yarn manufacturers
from time to time.

Material misstatements were identified during the prior year’s audit. Company A significantly
understated the yarn purchase from Company B. Company A also failed to identify two yarn
purchase transactions from Company C and make relevant disclosure in its financial
statements. As a result, Company A has implemented a regular purchase reconciliation
process with the subsidiaries at each month end starting from this year.

Required:

You are the audit engagement manager who is responsible for the audit of Company A’s
standalone financial statements.

(a) Identify two related party transactions of Company A in the current year.
(2 marks)

(b) Assess the risks of material misstatements in respect of the two related party
transactions identified in Question 8(a) and explain your views.
(5 marks)

(c) Propose audit procedures in response to the risks over completeness assertion
identified in Question 8(b).
(5 marks)

(d) The audit engagement senior said that the engagement team does not need to
perform detailed audit procedures on management’s presentation and
disclosure of related party transactions if the management has provided their
written representation that all related party transactions have been accounted
for, presented and disclosed properly. Suggest your proposed response and
explain your reasons.
(3 marks)

* * * END OF EXAMINATION PAPER * * *

Module C (December 2016 Session) Page 9 of 9