STANDARD CASES

ACCT 304 - AA

WEEK 2

Case 2 Audit Principles

(a) There are legal and professional arrangements for the appointment and removal of

auditors.

(i) State the circumstances in which a person is not eligible to act as an auditor.

(ii) Describe the steps required to remove an auditor from an engagement.

WEEK THREE - CORPORATE GOVERNANCE

Case 1

The directors of Murray Co are interested in being able to report that they comply

with best practice corporate governance principles and have asked for your thoughts.

The finance director has provided you with the following information: The board

consists of the chief executive officer, finance director, HR director, production

director and sales director. In addition there are two non-executive directors who were

appointed last year by the chief executive as they are his aunt and uncle. Previously

they ran their own small café and used a firm of accountants for all financial matters

due to their own lack of expertise in that area.

The contracts signed by the non-executive directors state that they are in place until

they decide to leave or unless they are found guilty of misconduct. They receive an

annual fee and a number of share options in Murray Co as their remuneration.

Since appointment, the two non-executives have formed an audit committee

consisting of themselves and the human resources director as it was felt that the

finance director would not be an independent member of the committee.

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They have also formed a remuneration committee with the finance director and are

currently in the process of proposing and approving the salaries for all of the directors

for the coming year.

Required:

(a) Explain whether Murray Co is required to comply with a code of

corporate governance.

(b) Explain the strengths of Murray Co’s current governance arrangements.

(c) Identify and explain the weaknesses in Murray Co’s current governance

arrangements and for each weakness recommend an action the company should take

to remedy the weakness.

CASE 2

You are the audit manager of Tela & Co, a medium sized firm of accountants. Your

firm has just been asked for assistance from Jumper & Co, a firm of accountants in an

adjacent country. This country has just implemented the internationally recognised

codes on corporate governance and Jumper & Co has a number of clients where the

codes are not being followed. One example of this, from SGCC, a listed company, is

shown below. As your country already has appropriate corporate governance codes in

place, Jumper & Co have asked for your advice regarding the changes necessary in

SGCC to achieve appropriate compliance with corporate governance codes.

Below is an extract from financial statements regarding corporate governance:

Mr Sheppard is the chief executive officer and board chairman of SGCC. He appoints

and maintains a board of five executive and two non-executive directors. While the

board sets performance targets for the senior managers in the company, no formal

targets are set for the board and no review of board policies is carried out. Board

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salaries are therefore set and paid by Mr Sheppard based on his assessment of all the

board members, including himself, and not their actual performance. Internal controls

in the company are monitored by the senior accountant, although a detailed review is

assumed to be carried out by the external auditors. SGCC does not have an audit

committee or an internal audit department.

Annual financial statements are produced, providing detailed information on past

performance.

Required:

(i) Explain SIX corporate governance deficiencies in SGCC, and

(ii) Recommend the changes necessary to overcome each deficiency.

WEEK 4 ETHICS AND ACCEPTANCE

CASE 1

Murray case study: Ethical issues

You are an audit manager in Wimble & Co, a large audit firm which specialises in

providing audit and accountancy services to manufacturing companies. Murray Co

has asked your firm to accept appointment as external auditor. Murray Co

manufactures sports equipment. Your firm also audits Barker Co, another

manufacturer of sports equipment, and therefore your firm is confident it has the

experience to carry out the audit.

You have been asked to take on the role of audit manager for Murray Co, should your

firm accept the engagement. You own a small number of shares in Murray Co, as you

used to be an employee of the company.

Don Henman, who has been the engagement partner for Barker Co for twelve years,

will take the role of engagement partner for Murray Co. The audit senior will be Tim

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Andrews, as his sister is the financial controller at Murray Co and therefore he knows

the business well.

Your firm recently purchased some bibs, footballs and other equipment from Murray

Co for the firm's annual football tournament. Murray Co has offered to provide this

equipment free of charge to the firm if they accept the role as auditor.

Murray Co would also like your firm to provide taxation and accounting services.

Specifically, the company would like you to prepare the financial statements and

represent the company in a dispute with the taxation authorities.

The fees for last year's audit of Barker Co have not yet been paid, and you have been

asked by Don Henman to look into the matter.

Required:

(a) Describe the steps Wimble & Co should take to manage the conflict of interest

arising from performing the audit of Murray Co and Barker Co.

(b) Explain the ethical threats which may affect the independence of Wimble &

Co in respect of the audit of Murray Co or Barker Co, and for each threat identify

ways in which the threat might be reduced.

CASE 2

Audit Principles

You are a manager in the audit department of Whilling and Abel. A potential new

client, Truckers Co, a haulage company, has approached your firm to do the external

audit in addition to some other non-audit services for the year-ended 30 September.

Your audit firm was recommended to Truckers Co by an existing client, O&P, a

shipping company who is also a major customer of Truckers Co.

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You have been chosen to lead the engagement as you have experience of auditing

haulage companies and you also manage the audit of O&P. Whilst arranging the

initial meeting with the directors of Truckers Co you discover that you studied

accountancy with the finance director at university.

Truckers Co has not made a profit for the last 2 years. The directors explain that this

is largely due to escalating costs in the industry including fuel price rises. They are

confident they have now controlled their costs for the current year. They have also

been approached to tender for a large profitable contract which would improve their

financial performance going forward. They would like you to assist them with the

preparation of this tender and present with them on the day.

The current year’s financial statements and audit are being finalised with another

audit firm. The finance director tells you that the current auditors have identified

material misstatements but the board of directors are refusing to make these

adjustments. If adjusted, it would turn the break-even position into a loss.

The current auditors have replied to your professional clearance letter and have

informed you that they are still owed fees relating to the prior year. This is under

dispute with the client. You calculate that the potential fees from Truckers Co would

amount to approximately 14% of your firm's total fee income.

Required:

Identify and explain the threats to independence if Whilling and Abel accept

Truckers Co as a new audit client. For each threat, recommend how the threat can be

managed.

(15 marks)

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WEEK 5 ETHICS AND ACCEPTANCE

CONFIDENTIALITY AND ETHICS

Audit Principles - Confidentiality

Client confidentiality underpins the relationship between Chartered

Certified Accountants in practice and their clients. It is a core element of

ACCA’s Code of Ethics.

Required:

(a) Explain the circumstances in which external auditors are permitted or required to

disclose information relating to their clients to third parties without the knowledge or

consent of the client.

(4 marks)

CASE 1

Confidentiality

(b) A waste disposal company has breached tax regulations, environmental

regulations and health and safety regulations. The auditor has been approached by the

tax authorities, the government body supervising the award of licences to such

companies and a trade union representative. All of them have asked the auditor to

provide them with information about the company. The auditor has also been

approached by the police. They are investigating a suspected fraud perpetrated by the

managing director of the company and they wish to ask the auditor certain questions

about him.

Required:

Describe how the auditor should respond to these types of request.

(6 marks)

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(Total: 10 marks)

CASE 2

Ethics Threat

You are a manager in the audit firm of JT & Co and this is your first time you have

worked on one of the firm's established clients, Pink Co. The main activity of Pink Co

is providing investment advice to individuals regarding saving for retirement,

purchase of shares and securities and investing in tax efficient savings schemes. Pink

Co is a listed company regulated by the relevant financial services authority.

You have been asked to start the audit planning for Pink Co, by Mrs Goodall, a

partner in JT & Co. Mrs Goodall has been the engagement partner for Pink Co, for the

previous seven years and so has a sound knowledge of the client. Mrs Goodall has

informed you that she would like her son Simon to be part of the audit team this year;

Simon is currently studying for his first set of papers for his ACCA qualification.

Mrs Goodall also informs you that Mr Supper, the audit senior, received investment

advice from Pink Co during the year and intends to do the same next year.

In an initial meeting of Pink Co you learnt that the audit team will not be entertained

on Pink Co’s yacht this year since this could appear to be an attempt to influence the

audit opinion. Rather a date has been arranged at the horse races costing less than

two-fifth of the expense of using the yacht and hopes this will be acceptable.

JT & Co has done some consulting work previously and the invoice is still

outstanding.

Required:

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Identify and explain the treats to independence in relation to the audit of Pink CO by

JT & Co. For each threat recommend how the threat can be managed.

WEEK 6 RISK

CASE 1

Murray Case Study: Audit Risks

Your firm Wimble & Co has recently accepted appointment as auditor of Murray Co

(a manufacturer of sports equipment). Having sold your shares in Murray Co, you

have been assigned as audit manager and you have started planning the audit

(although you were an employee of Murray Co, this was many years ago and you did

not have any involvement in the preparation of the financial statements). You have

held a meeting with the client and have ascertained the following:

Murray Co manufactures sports equipment. Most items of equipment, such as tennis

rackets, hockey sticks and goals, take less than one day to manufacture. Murray Co's

largest revenue generating product, ergometers (rowing machines), takes up to one

week to manufacture.

Murray Co refurbished the assembly line for the ergometers during the year. Murray

Co uses a third party warehouse provider to store the manufactured ergometers and

approximately one quarter of the other equipment.

Historically, Murray Co has only sold to retailers. For the first time this year, Murray

Co has made sales directly to consumers, via a new website. The website is directly

linked to the finance system, recording sales automatically. Website customers pay on

ordering. The website development costs have been capitalised. This initiative was

implemented to respond to market demands, as retailer sales have fallen dramatically

in the last two years. Some of Murray Co's retail customers are struggling to pay their

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outstanding balances. Several of the sales team were made redundant last month as a

result of the falling retailer sales. Murray Co is planning to list on the stock exchange

next year.

Required:

Using the information provided, describe SIX audit risks and explain the auditor's

response to each risk in planning the audit of Paa Kwasi & Co.

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CASE 2

Below is the statement of financial position and the income statement of Paa Kwasi &

Co. provided to you during an audit exercise.

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Paa Kwasi & Co

Required:

Using the financial information provided, and the information from TYU 1, perform

analytical procedures on the draft financial statements of Murray Co and explain the

audit risks that arise.

CASE 3

You are an audit senior at JPR Edwards & Co and you are currently planning the audit

of Hook Co for the year ending 30 June. Your firm was appointed as auditor in

January after a successful tender to provide audit and tax services. JPR Edward & Co

were asked to tender after the lead partner, Neisha Selvaratalm, met Hook Co’s CEO,

Pete Tucker, at a charity cricket match. Neisha explained that they were unhappy with

the previous auditors as Pete Tucker felt their audit didn’t add much value to Hook

Co. Hook Co manufacturer’s electrical goods such as MP3 players, smart phones and

personal computers for the entertainment market. They do not retail their goods under

their own name but manufacture for larger companies with established brands. Their

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key client, who represents 70% of their revenue, was the market leader in smart

phones and MP3 players last year with 60% market share.

Hook Co uses a number of suppliers to source components for their products. Most

suppliers are based in the UK however Hook Co imports microchips, a key

component in all their goods, from a number of suppliers based in San Jose, Costa

Rica. They assemble their goods in their one factory in Staines, UK, and package their

products for their customers before distribution across the UK.

During the year Hook Co started developing applications which can be downloaded

onto their smart phones. They have spent $1 million on an application called “snore-

o-meter” which allows the users to record the sounds they make while they are asleep.

There was a technical difficulty in production which meant the launch of “snore-o-

meter” was delayed from the 31 March to its anticipated release on the 31 July.

To fund their expansion into Smartphone applications Hook is seeking a listing on the

London Stock Exchange in the fourth quarter of the year.

Required:

Using the information provided, describe FIVE audit risks and explain the auditor's

response to each risk in planning the audit of Hook Co.

(10 marks)

WEEK 6 PLANNING

CASE 1

You are an audit senior responsible for understanding the entity and its environment

and assessing the risk of material misstatements for the audit of Rock Co for the year-

ending 31 December. Rock Co is a company listed on a stock exchange. Rock Co is

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engaged in the wholesale import, manufacture and distribution of basic cosmetics and

toiletries for sale to a wide range of stores, under a variety of different brand names.

You have worked on the audit of this client for several

years as an audit junior.

Required:

(a) Describe the information you will seek, and procedures you will perform in order

to understand the entity and its environment and assess risk for the audit of Rock Co.

(10 marks)

(b) You are now nearing the completion of the audit of Rock Co. Draft financial

statements have been produced. You have been given the responsibility of performing

a review of the audit files before they are passed to the audit manager and the audit

partner for their review.

You have been asked to concentrate on the proper completion of the audit working

papers. Some of the audit working papers have been produced electronically but all of

them have been printed out for you.

Required:

Describe the types of audit working papers you should expect to see in the audit files

and the features of those working papers that show that they have been properly

completed.

(10 marks)

(Total: 20 marks)

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WEEK 7 SYSTEMS AND CONTROLS

CASE 1

Rhapsody Co supplies a wide range of garden and agricultural products to trade and

domestic customers. The company has 11 divisions, with each division specializing in

the sale of specific products, for example, seeds, garden furniture, and agricultural

fertilizers. The company has an internal audit department which provides reports to

the audit committee on each division on a rotational basis. Products in the seed

division are offered for sale to domestic customers via an Internet site. Customers

review the product list on the Internet and place orders for packets of seeds using

specific product codes, along with their credit card details, onto Rhapsody Co's secure

server. Order quantities are normally between one and three packets for each type of

seed. Order details are transferred manually onto the company's internal inventory

control and sales system and a two-part packing list is printed in the seed warehouse.

Each order and packing list is given a random alphabetical code based on the name of

the employee inputting the order, the date and the products being ordered. In the seed

warehouse, the packets of seeds for each order are taken from specific bins and

dispatched to the customer with one copy of the packing list. The second copy of the

packing list is sent to the accounts department where the inventory and sales computer

is updated to show that the order has been dispatched. The customer's credit card is

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then charged by the inventory control and sales computer. Bad debts in Rhapsody are

currently 3% of the total sales. Finally, the computer system checks that for each

charge made to a customer's credit card account, the order details are on file to prove

that the charge was made correctly.

Required:

In respect of sales in the seeds division of Rhapsody Co:

(i) Explain FOUR deficiencies in the sales system, and

(ii) For each deficiency provide a recommendation to overcome that deficiency.

CASE 2

a. Define ‘tests of control’ and explain the importance of tests of control in the

audit of a company.

b. You are an audit senior working at a medium sized firm of auditors. One of

your clients is an exclusive hotel called ‘Numero Uno’ situated in the center of

Big City. As part of your audit procedures you are assessing the controls

surrounding payroll. You have read last year’s audit file and have obtained the

following information: The hotel employs both full and part time staff. Due to

the nature of the business most of the work is done in shifts. All staff are paid

on a monthly basis. New members of staff are given an electronic photo

identification card on the day they join by the personnel department. This card

is used to ‘clock in’ and ‘clock out’ at the start and end of the shift to record

the hours worked. At the end of each week the information recorded on the

system is sent automatically to the payroll department and also to the head of

each of the three main operating divisions: Rooms, Food & Beverage and

Corporate Events. Each division head must reply back to the payroll

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 department by email to authorize the hours worked by their staff. The payroll

clerk collates all the authorized information and then inputs the hours worked

into a standardized computerized payroll package. This system is password

protected using an alphanumerical password that only the payroll clerk and the

finance manager know. Once the hours have been entered, the calculations of

gross pay and taxation are calculated automatically along with any other

statutory deductions. At the end of the calculations a payroll report is

produced and printed. The finance manager reviews the report and compares

the data to last month to identify and follow up any unusual variances. When

he is satisfied with the information, he authorizes the payroll run by signing

the payroll report and the payroll clerk submits the data. Pay-slips are sent to

the home address of each employee and payment is made by bank transfer.

Required: With reference to the scenario:

(i) Identify and explain FOUR STRENGTHS within the hotel’s internal

control system in respect of payroll.

(ii) For each of the identified strengths, state a test of control the auditor

could perform to assess if the controls are operating effectively.

WEEK 8 INTERNAL AUDIT

CASE 1

Murray Co’s Internal Audit Function

The internal audit function at Murray Co consists of a head of internal audit, two

senior internal audit managers, four internal audit managers, seven internal auditors

and an internal audit assistant. The head of internal audit has been in post for twelve

years, and the other members of the team have varying lengths of service from two to

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fifteen years. The head of internal audit is responsible for recruiting staff into the

internal audit team. The head of internal audit was appointed by the audit committee.

The head of internal audit reports to the audit committee and agrees the scope of work

for the internal audit function with the audit committee. The internal audit staff have

no operational responsibility. Where the staff have previously transferred from

another department within Murray Co, the head of internal audit ensures that another

member of the team carries out the audit of that system. Murray Co's internal audit

function follows the International Standards for the Professional Practice of Internal

Auditing issued by the Global Institute of Internal Auditors.

Barker Co’s Internal Audit Function

The internal audit function at Barker Co consists of a chief internal auditor, one senior

internal audit manager, one audit manager, one auditor and an audit assistant. The

chief internal auditor has been in post for ten years, and the other members of the

team have varying lengths of service from five to nine years. The finance director is

responsible for recruiting all staff into the internal audit function. The chief internal

auditor reports to the finance director and agrees the scope of work for the internal

audit function with him. The internal audit team spend 50% of their time carrying out

internal audit assignments and 50% of their time working in the finance department.

Due to the limited number of staff in the team, this has resulted in the internal auditors

reviewing their own work. Barker Co's internal audit team follow a variety of

standards, in accordance with their own professional training.

Required:

Compare and contrast the effectiveness of Murray Co and Barker Co's internal audit

functions

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CASE 2

You are the senior manager in the internal audit department of Octball, a limited

liability company. You report to the chief internal auditor and have a staff of six

junior auditors to supervise, although the budget allows for up to ten junior staff. In a

recent meeting with the chief internal auditor, the difficulty of staff recruitment and

retention was discussed. Over the past year, five junior internal audit staff have left

the company, but only two have been recruited. Recruitment problems identified

include the location of Octball’s head office in a small town over 150 kilometres from

the nearest major city and extensive foreign travel, often to cold climates. Together

with the chief internal auditor you believe that outsourcing the internal audit

department may be a way of alleviating the staffing problems. You would monitor the

new outsourced department in a part-time role taking on additional responsibilities in

other departments, and the chief internal auditor would accept the post of finance

director (FD) on the board, replacing the retiring FD. Two firms have been identified

as being able to provide the internal audit service:

Two firms have been identified as being able to provide the internal audit service:

•The NFA Partnership, a large local firm specialising in the provision of accountancy

and internal audit services. NFA does not audit financial statements or report to

members.

•T&M, Octball’s external auditors, who have offices in 75 countries and employ in

excess of 65,000 staff.

Required:

(a) Discuss the advantages and disadvantages of appointing NFA as internal auditors

for Octball.

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(b) Discuss the matters T&M need to consider before they could accept appointment

as internal auditors for Octball.

(c) Assume that an outsourcing company has been chosen to provide internal audit

services. Describe the control activities that Octball should apply to ensure that the

internal audit service is being maintained to a high standard.

WEEK 9 EVIDENCE AND PROCEDURES

CASE 1

You are an audit senior working at a medium sized firm of auditors. One of your

clients is an exclusive hotel, Numero Uno, situated in the centre of Big City. Numero

Uno prides itself on delivering a first-class dining experience and is renowned for its

standards of service and cooking that few restaurants in the country come close to. Its

inventory therefore consists of the very best foods and beverages from across the

globe. Food products held in inventory are mostly fresh as the head chef will only

work with the very best ingredients. Food inventory is stored in the kitchens and

managed by the head chef himself. The majority of beverages held at the hotel are

expensive wines that have been sourced from exclusive vineyards. The hotel also

stocks a wide range of spirits and mixers. All beverages are stored either in the hotel

cellar or behind the bar. The cellar can only be accessed by the duty manager who

holds the key. As part of your audit procedures you will attend the year-end inventory

count of the hotel’s beverages.

Required:

(a) Describe the audit procedures an auditor would conduct before and whilst

attending the inventory count of the beverages in the hotel.

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 (b) Identify and explain THREE financial statement assertions that are most

relevant to inventory.

(c) Apart from attending the inventory count, describe the substantive procedures

an auditor would carry out to confirm the valuation of the wine and spirits held in

inventory at the year-end.

CASE 2

You are the auditor of BearsWorld, a company which manufactures and sells small

cuddly toys by mail order. The company is managed by Mr Kyto although due to

other business commitments Mr Kyto only visits the office once a week. BearsWorld

employs two assistants. One assistant maintains the payables ledger, orders inventory

and pays suppliers. The other assistant receives customer orders and despatches

cuddly toys. Mr Kyto authorises important transactions such as wages and large

orders. At any time, about 100 different types of cuddly toys are available for sale. All

sales are paid for at the time of ordering. Customers pay using credit cards and

occasionally by sending cash. Revenue is over $5.2 million. You are planning the

audit of BearsWorld and are considering using some of the procedures for gathering

audit evidence recommended by ISA 500 Audit Evidence as follows:

• Analytical procedures

• Inquiry

• Inspection

• Observation

• Recalculation.

Required:

For each of the above procedures in relation to the audit of Bearsworld:

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(i) Explain its use in gathering audit evidence.

(ii) Describe one example how it could be used.

(iii) Explain the benefits of each procedure.

(iv) Explain the limitations of each procedure

WEEK 10 COMPLETION AND REVIEW

CASE 1

Murray case study: Going concern review for the year-ended 31 December 20X4

On 2 January 20X5, Golf is Us, a major customer of Murray Co, was placed into

administration owing $211,000. On 3 January 20X5, the sales director left the

company and has yet to be replaced. The sales director is suing Murray Co for

constructive dismissal. On 5 January 20X5 there was a fire at the premises of the

third-party warehouse provider, which destroyed all inventory held there.

Approximately one half of Murray Co's inventory was stored in these premises. The

assembly line for ergometers (rowing machines) was refurbished during the year at a

cost of $1m. The additional $1.5m loan facility provided to Murray Co during the

year is secured, in part, on the refurbished assembly line. The assembly line broke

down during January and six weeks later is still not working. The company is seeking

new funding through an initial public offering of shares in the company (i.e. listing on

the stock exchange). In the event that the initial public offering does not proceed, this

will require Murray Co's existing banking arrangements to be renegotiated and

additional funding to be raised from either existing or new investors. The financial

statements of Murray Co show an overdraft at 31 December 20X4 of $180,000

(20X3: $120,000). The overdraft limit is $250,000. The cash flow forecast shows

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negative monthly cash flows for the next twelve months. As a result of cash shortages

in February 20X5, a number of suppliers were paid late.

Required:

Using the information provided, explain the potential indicators that Murray Co is not

a going concern.

CASE 2

Smithson Co provides scientific services to a wide range of clients. Typical

assignments range from testing food for illegal additives to providing forensic

analysis on items used to commit crimes to assist law enforcement officers. The

annual audit is nearly complete. As audit senior you have reported to the engagement

partner that Smithson is having some financial difficulties. Income has fallen due to

the adverse effect of two high-profile court cases, following which a number of clients

withdrew their contracts with Smithson. A senior employee then left Smithson, stating

lack of investment in new analysis machines was increasing the risk of incorrect

information being provided by the company. A cash flow forecast prepared internally

shows Smithson requiring significant additional cash within the next 12 months to

maintain even the current level of services.

Required:

(a) Define 'going concern' and discuss the auditor's and directors'

responsibilities in respect of going concern.

(b) State the audit procedures that may be carried out to try to determine whether or

not Smithson Co is a going concern.

(c) Explain the audit procedures and actions the auditor may take where the auditor

has decided that Smithson Co is unlikely to be a going concern.

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WEEK 11 REPORTING

CASE 1

Henry

(a) Aragon Co-operates a perpetual inventory system. No year-end count is

performed. You have reviewed the level of adjustments made each month after each

perpetual count and concluded that due to the significance of the adjustments, the

inventory system is not reliable. You have requested that a full year-end count is

performed but management have refused saying it would be too disruptive. The

inventory balance is $4 million. Sales revenue is $50 million and profit for the year is

$15 million.

(b) Boleyn Co has not made allowance for an irrecoverable debt of $50,000 in respect

of a customer declared bankrupt just after the year-end. Profit for the year is

$500,000.

(c) Seymour Co is being sued by a competitor for the theft of intellectual property.

The amount of the claim is material and the case could go either way. The claim is not

mentioned anywhere in the financial statements.

(d) Howard Co is a cash retailer. There is no system to confirm the accuracy of cash

sales.

(e) Cleves Co has neglected to include a statement of profit or loss in its financial

statements.

f) Parr Co is involved in a major court case that would bankrupt the company if lost.

The directors assess and disclose the case as a contingent liability in the accounts. The

auditors agree with the treatment and disclosure.

Required:

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For each of the above situations describe the implications for the independent

auditor's report.

CASE 2

You are the audit manager of Brakes Co, a listed client. Brakes Co is a global

manufacturer of braking systems for use in domestic and commercial motor vehicles.

$250,000 was raised through a new share issue in the year. Draft profit before tax is

$9m and total assets are $37m. The audit is nearly complete and you are undertaking

an overall review of the audit evidence on file.

(a) Explain the importance of the overall review of evidence obtained.

(b) During your review you notice that the section of the file relating to share capital

and reserves is incomplete.

Required:

Describe audit procedures that should be performed in respect of Brake’s share capital

and reserves.

(c) The following matters arising during the audit of Brakes Co have been noted on

file for your attention:

(i) A customer of Brakes Co had to withdraw one of their family car models this year

due to concerns over the safety of the braking system. The customer has lodged a

legal claim against Brakes Co for $10 million for the negligent supply of faulty

braking systems. The company’s lawyers believe that there is an 80% chance that

Brakes Co will lose the case but the directors believe that their quality control

procedures have always been robust and that the braking systems will be proven to

have been safe. They have however decided to disclose the matter in the financial

statements as a contingent liability.

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(ii) Brakes Co also produces and sells brake fluid. Another customer has recently

returned a small batch of brake fluid because the fluid appeared to be contaminated

with oil. Brakes Co issued the customer with a credit note for the full value of

$137,500 and correctly accounted for this in the draft financial statements. As the

brake fluid was returned before the year-end, Brakes Co has included it in the year-

end inventory listing at cost of $125,000. Brakes Co may be able to re-filter and re-

sell the brake fluid at the original selling price, but filtering will cost a further

$62,500.

(iii) Four months ago, Brakes Co began renting some additional warehouse space

from a third-party storage provider, Wheels Co. At the year end, raw materials with a

value of $3.2 million belonging to Brakes were stored at Wheels Co's premises. The

directors of Brakes Co did not make you aware of the new third-party storage facility.

Consequently, no audit procedures were performed to verify the raw materials.

Required:

Discuss each of these issues and describe the impact on the independent auditor's

report if the above issues remain unresolved.

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