sample essay of BAO3306 Auditing

a lot of students fell that auditing is hard, but i really think it is a funny unit. i am not sure it is a useful unit, but it still fun.
OK, the questions of the assignment:

Background


Solace Limited (Solace) is a listed Australian company specialising in private tutoring services. Samantha Solace, a former school teacher who felt the Australian marketplace lacked high quality, low priced tutoring services, originally founded Solace. Samantha initially started providing private tutoring at home. She worked for a few years until the business took off and Samantha had to lease new premises and moved her operations there to keep up with the increasing demands.
Solace was incorporated in 2002 and listed on the Australian Stock Exchange in 2007. Since listing, profits for the company have been fluctuating, but Samantha feels as if they have a promising future as the market penetration of Solace improves. Since incorporation, Samantha has been the Chairperson and the CEO of Solace. Samantha remains closely involved in the day-to-day running of the business, taking a hands-on approach to the running and marketing of her tutoring services. Samantha personally oversees all of Solace’s operations. She frequently travels interstates as well as around south-east Asia to search for new opportunities as well as improving the current services offered by Solace. All the tutoring services are accredited and Solace is a member of the Australian Council for Private Education and Training (ACPET).
Over the past three years, Samantha has filled senior management positions at Solace by recruiting highly regarded managers from competing service providers (both local and overseas firms). In order to obtain these high-quality staff members, Samantha has had to offer attractive salary packages including a share option plan that is tied to a variety of financial performance benchmarks and share price. Despite the high cost of recruiting these senior managers, Samantha is happy as they all have good records of providing highly competent and ethical leadership.
In addition to providing tutoring services from Prep to Year 12, Solace also involves in real estate business. Solace’s philosophy is to initially lease premises to set up classrooms to cater for local students. Once the business grows, Solace offers to purchase the premises from the owner. The purchased premises are then demolished, developed or renovated to service the local population.
Solace’s current focus is to penetrate the Australian marketplace and achieve a market share of at least 30%. In an effort to strengthen its position and further build brand awareness, Solace plans to acquire other, smaller service providers that would fit with Solace’s current range of services.

Until 2008, Solace was audited by a small accounting firm which Samantha had always used for her personal tax and accounting affairs. However, Samantha felt that the small firm would not have enough experience for a listed company, so in early 2008 she approached Brian Shaun, an audit partner of BWE, a mid-size chartered accounting firm.
For the 2009 audit, BWE has appointed Brian Shaun as the audit partner due to his experience in the education sector. Brian currently has three other clients in this sector and was a school teacher himself until he became a registered company auditor. Brian has over 20 years experience as a chartered accountant and has had clients in this sector for the past 7 years. Since BWE took over the audit, there have been no problems with the audit.

Part A

Olga is part of an audit team who have been sent to Laos to conduct an audit of one of Solace's subsidiary companies. During the audit Olga uncovers a series of bribes that the company has paid to local authorities. Bribes are considered a normal part of business in this particular country so the subsidiary company feels as though they have done nothing wrong. It is likely that the bribes will not be uncovered but there is a chance that they will be, and that Solace, BWE, and Olga personally will all suffer negative consequences if they are. If Olga does report the bribes then the subsidiary company will suffer and there will be a scandal for Solace. However, the impact of reporting the bribes is likely to be less than if they are discovered at a latter date by other authorities. Olga thinks of herself as an honest person and is trying to decide what the ethically 'right' thing to do is.


Required

(a) Describe three different ethical theories.

(b) Try to determine what decision Olga will make regarding whether or not she will report the bribes by applying the ethical theories of teleology, deontology, virtue ethics, and ethical relativism.

Part B

Following the collapse of a number of high profile educational service providers in recent time, Brian is concerned about auditor’s legal liability in relation to those collapses.


Required:

(a) Explain the impact that the Pacific Acceptance case had on existing auditing practice.

(b) List four of the procedures or practices that were identified in the ruling as being part of a competent audit.

Part C

BWE is determining whether to accept an audit engagement with Solace Ltd. As this would be a new engagement the audit firm sought Solace's permission to contact the previous auditor. Solace did not give their permission, explaining that they did not want the previous auditors to know they were thinking of changing. Recently, Solace Ltd had been in the media for management not disclosing that one of its subsidiaries is being investigated by local authority for suspicion of bribery. The incident is still under investigation but if the subsidiary is found to be at fault then they may be subject to heavy fines from local authority and lose their business licence.
Required:

From the information provided above, identify four reasons for not accepting the audit engagement with Solace Ltd.
Part D

BWE Audit Firm was planning the audit for its existing client, DEF Learnings. The audit partner was trying to determine the best audit strategy to use. DEF Learnings. is a small private tutoring company that does not have any warehousing facilities as all stock in the form of educational materials is kept on the premises. Being small, they only have a small team of staff, which makes the separation of duties principle difficult to achieve. The preliminary tests of controls found that the internal control procedures are well designed, but not always observed due to the small amount of staff. Previous experience with this client also showed that controls were not always observed. Despite this, BWE has never discovered a material misstatement in the accounts.
Required:

Determine what audit strategy should be used and justify your answer.

it is really a long question...
SAMPLE:
Part A


(a) Describe three different ethical theories.

Teleology: Teleology (consequentialism) considers actions or behaviour according to the consequences of that behaviour. An action is right because it produces some specified type of consequence, i.e. welfare, wealth, happiness, pleasure or knowledge. The most common form of consequentialism is utilitarianism. (Leung P. & Corman P, 2009, p.68) It is teleological because actions are assessed in terms of the consequences – the final or end result.

Consequentialism identifies the moral worth of conduct in terms of how well that conduct produces some effect. It has a ‘forward-looking’ rationale in determining what one ought to do. (Leung P. & Corman P, 2009, p.68)

Deontology: it is an approach to ethics that holds that acts are inherently good or evil. (wikipedia, 2009) According to deontological ethics, an action is right because of the process, i.e. the intention, rather than its outcome. In deontology the emphasis is on individual duty such as telling the truth, acting justly or keeping promises. (M. Gaffikin, 2007) Morality is a matter of doing one's duty, regardless of consequences, and that one must be consistent and carry out one's duties under all circumstances. Morality and rationality are closely connected with logical consistency. (Leung P. & Corman P, 2009, p.68) As teleology, deontology is also a normative ethical theory.

Virtue ethics: the one that emphasizes the virtues, or moral character, rather than rules and consequences. (Stanford, 2009)Moral behaviour is a natural result of one's character. Under this theory, ethics is not just a matter of what people do; it is a matter of what people are. Virtue ethics covers human qualities such as courage, honesty and loyalty. (Leung P. & Corman P, 2009, p.69) Some criticise the theory in relation to the difficulty involved with establishing the nature of the virtues. Different people, cultures and societies often have vastly different opinions on what constitutes a virtue. Virtue ethics is currently one of three major approaches in normative ethics. (wikipedia, 2009)

(b) Try to determine what decision Olga will make regarding whether or not she will report the bribes by applying the ethical theories of teleology, deontology, virtue ethics, and ethical relativism.

No matter using which ethical theories to analyse this issue, Olga will report the bribes.

(i) Teleology

Olga has two options, one is reporting the bribes, and the other is not. If Olga does report the bribes, the consequence will be that the subsidiary company suffers and there will be a scandal for Solace. On the other hand, it is likely that the bribes will not be uncovered. But there is a chance that they will be uncovered, and that Solace, BWE and Olga personally will all suffer negative consequences if they are. Comparing these two consequences, the impact of reporting the reporting the bribes is likely to be less than if they are discovered at a latter date by other authorities. So the consequence is received from reporting the bribe is much better than the result if Olga chose not to do so. Under teleology theory, an action is right because it produces some good consequences. Hence, Olga will report the bribe.

(ii) Deontology

Under deontology theory, an action is right because one's duty is to be honest, which is simply the ‘right thing to do’. (Leung P. & Corman P, 2009, p.68) Olga is an auditor, so her duty is reporting all her findings, and makes sure the auditors’ report is true and fair. According to deontological ethics, an action is right because of the right process. So reporting the bribes is the right action, this action is accordance with the Corporate Law and other ethical coeds. Under deontology ethics, Olga should report the bribes.

(iii) Virtue Ethics

Under virtue ethics, it states that the ability of a person to act morally based on his or her character. Thus ethics is not just a matter of what people do, it is a matter of what people are. (Leung P. & Corman P, 2009, p.69)In the scenario, Olga thinks of herself as an honest person, so under virtue ethics theory, she will report the bribes.

(iv) Ethical relativism

Ethical relativism is a view that moral values are relative to a particular environment. This subsidiary company locates in Laos, and bribes are considered a normal part of business. However, it is important to note that tolerating culture differences does not mean being indifferent to ethical principle. Although specific rules might differ from culture to culture, those specific rules are, nevertheless, grounded in the same basic principles. Respect for a host culture does not include excuses for inducements, secret commissions and bribes. (Leung P. & Corman P, 2009, p.69) Olga still need to report the bribes, although bribes are very common in Laos.

To sum up, Olga should report the bribes by applying the ethical theories of teleology, deontology, virtue ethics and ethical relativism.

Part B

(a) Explain the impact that the Pacific Acceptance case had on existing auditing practice

The Pacific Acceptance case was a cornerstone in Australia, because it was the first major case to review auditing under modern concepts with respect to what is reasonable due care and diligence. The Pacific Acceptance case established some of the key features of professional due care expected of an auditor. The Pacific Acceptance case is of great importance in considerable detail the role of the auditor, the nature of the duties which the law imposed upon the auditor, and the standards of performance by which those duties were to be fulfilled. (Leung P. & Corman P, 2009, p.130)In the case the Pacific auditors were held negligent in a number of respects, the failures noted by Moffitt J provide useful detailed guidance to any auditor in the conduct of an audit. The case also caused considerable turmoil in the profession. There was concern that the case had established new and unrealistic standards for the auditing profession. In this case, it states that no part of an auditor’s duty to detect fraud or to conduct the audit in a way aimed specifically at detecting fraud. An auditor is not under any prima facie duty to detect fraud, but if fraud is detected during the course of the audit, the Pacific Acceptant case indicates that there is a duty promptly to warn the client of the existence of fraud. (Gul. F., Teoh. H at el, 1994,p.44)

(b) List four of the procedures or practices that were identified in the ruling as being part of a competent audit.

• Pay due regard to the possibility of material fraud or error in framing or carrying out audit procedures so the auditor has a reasonable expectation that the fraud or error will be detected. (Leung P. & Corman P, 2009, p.130) Whenever an auditor enters into an agreement to conduct an audit there is a contractual obligation to execute the task in accordance with the standards of a reasonably competent member of the profession. This is a term of any contract, though often unwritten or implied.

• Promptly report fraud or warn of suspicion of fraud, whether material or not. (Leung P. & Corman P, 2009, p.130) An auditor has the duty to warn of any fraud or major error detected during the course of the audit. The auditor has the duty to report the auditor’s opinion on the truth and fairness of the published accounts.

• Closely supervise and review the work of inexperienced staff. (Leung P. & Corman P, 2009, p.130) In the case the company employed inexperienced staff without adequately supervising and checking their work. Sometimes the inexperienced staff know few about how to deal with the issue, they need to be supervised and guided well.

• Audit the whole of the year, not just the year-end balances; the duty to audit encompasses the client's financial affairs throughout the period of appointment and is not confined to reporting on the year-end balances as presented in the accounts. (Leung P. & Corman P, 2009, p.130) So when the auditors audit an entity, they should check all the accounts in the financial year.

Part C

From the information provided above, identify four reasons for not accepting the audit engagement with Solace Ltd.

APES 320 Quality Control for Firms (ISQC 1) requires that an audit firm should establish client evaluation and acceptance procedures that ensure that the firm accepts audit engagements only where it has considered the client’s integrity and where it is competent and is able to meet the ethical requirements. (Leung P. & Corman P, 2009, p.226) In the scenario, BWE should not accept the audit engagement with Solace Ltd, the reasons are:

(i) In undertaking a client evaluation, the auditor seeks reasonable assurance that an entity’s management can be trusted. For a new client, the proposed auditor may obtain information about the integrity of management by communicating with the predecessor auditor. The reason of doing that is the previous auditor’s working paper files are also valuable source of information about a new client, reviewing those paper helps new auditor to know the firm’s situation. It is a way to check client’s integrity. But in fact, BWE sought Solace’s permission to contact the previous auditor. Solace did not give their permission. As Section AUST210.11.1 of the Code of Ethics states that the proposed accountant who is asked to replace the existing auditor must ask the prospective client’s permission to communicate with the existing auditor — if refused, the auditor should decline the engagement (unless there are exceptional circumstances). (Leung P. & Corman P, 2009, p.227) There is another way to check the integrity of management, which is making enquiries of other third parties. The auditor may obtain information about a client management’s integrity from knowledgeable people in the community. But in the scenario, there is no evidence shows that BWE has asked any third party any information about Solace, in another word, so far BWE has known nothing about the previous financial poison and performance of Solace. So for lacking of communicating with existing auditors or enquiring of other third parties, BWE can not assess the integrity of Solace’s management. It should not accept the audit engagement with Solace Ltd.

(ii) Before accepting the audit engagement, the auditors should assess a prospective client’s legal and financial stability. Some entities whose operations or main products are the subjects of either material lawsuits or investigations by authorities, the outcome of which could adversely affect the viability of the business. For this kind of entities, the auditor should reject prospective clients. (Leung P. & Corman P, 2009, p.227) This kind entity can not keep the legal stable, they pose a high risk of litigation. One of Solace’s subsidiaries is being investigated by local authority for suspicion of bribery, and the consequence probably is that the company will lose its license. If BWE accepts the engagement, and some day, Solace is sued by the authority or other organisation. If Solace can find any pretext for claiming reliance on the financial statement, then such litigation will probably also involve BWE. Then, BWE may incur the financial and other costs of defending themselves. That’s not good for the BWE, so it is not a good choice to accept the audit engagement with Solace Ltd. Besides checking prospective client’s legal stability, the auditors should check whether the financial position is stable. In this case, the subsidiary is being investigated but if it is found to be at fault then it may be subject to heavy fines from local authority. If it happened, it must affect the financial position of Solace. Now Solace is potentially suffering a financial problem, so it is not a good time for BWE to accept the engagement letter with it.

(iii) Ethical principles require the auditor to exercise due care in performing the audit and preparing the report. The auditor should decline an engagement if due professional care can not be exercised throughout the audit. (Leung P. & Corman P, 2009, p.228) In the scenario, Solace has enlarged their business, not only private tutoring, but also real estate business. There is no doubt that BWE has the ability to audit the private tutoring sector, but for the real estate sector, there is no evidence shows that BWE can deal with it professionally. Furthermore, BWE is a mid-size chartered accounting film, so whether it has enough capability of auditing the oversea business of Solace is questioned.

(iv) Before accepting a new audit client, the firm must evaluate whether there are any circumstances that would compromise its independence. One procedure is to circulate the name of a prospective client to all professional staff to identify any financial or business relationships inconsistent with independence. In addition, the firm should determine that acceptance of the client engagement would not result in any conflict of interest with other clients. (Leung P. & Corman P, 2009, p.228) In this case, BWE has appointed Brian Shaun as the audit partner. There is no doubt that Brian is a chartered accountant, but he has had clients in this sector for the past 7 years. One auditor audits two companies in the same sector in the same time, that’s may cause the problem of conflict of interest. So it potentially shows that, if BWE accept the engagement with Solace, there will be a conflict of interest with other clients.

Conclusion, BWE can not assess Solace’s integrity, and it is not competent and is not able to meet the ethical requirements (independence and due care). So BWE should not accept the audit engagement letter with Solace.
Part D

Determine what audit strategy should be used and justify your answer.

The audit strategy significantly affects the detailed work performed in the audit. The interrelationship among evidence, materiality and the components of audit risk affects the auditor’s decision on the type of strategy chosen.

In many situations it is apparent to the auditor during the course of planning the audit that there is nothing to be achieved by assessing control risk as less than high. In such situations the auditor plans an audit consisting entirely of substantive procedures. (Leung P. & Corman P, 2009, p.330) So BWE can use predominantly substantive approach to audit DEF Learnings, the reasons are:

(1) the entity is small, such that controls are unlikely to be effective

DEL Learnings is a small private tutoring company and only have a small team of staff. And it makes the separation of duties principle difficult to achieve.

(2) previous audits have revealed inadequate controls

Previous experience with this client also showed that controls were not always observed.

(3) the understanding of the internal control structure reveals that controls are inadequate

The preliminary tests of controls found that the internal control procedures are well designed, but not always observed because of the small amount of staff.

(4) there are few transactions in a transaction class or items making up an account balance, such that substantive procedures are unlikely to be costly.

DEF Learnings is a very small company, it even does not have any warehousing facilities. So it can be forecasted that there will be not many transactions happened during the whole year. And also BWE has never discovered a material misstatement in the accounts. Hence substantive procedures are unlikely to be costly.

If the auditor assesses that appropriate controls do not exist or are likely to be ineffective, then no reliance can be placed on internal controls- control risk is assessed at a relatively high level and therefore a predominantly substantive approach will be adopted. (Leung P. & Corman P, 2009, p.330)

In conclusion, BWE should use predominantly substantive approach.

Reference


Gul. F., Teoh. H, Andrew. B. & Schelluch. P., 1994, Theory and practice of Australian Auditing, 3rd edition, Thomas Nelson Australia

Gaffikin. M, 2007, Accounting Theory and Practice: the Ethical Dimension, University of Wollongong, Australia

Leung. P., Corman. P., Cooper. B. & Richardson. P., 2009, Modern Auditing & Assurance Services, 4th edition, John Wiley & Sons, Milton, Qld.
Deontology,2009, http://en.wikipedia.org/wiki/Deontology [accessed at 17th May 2009]

Ethics-virtue, 2009,http://plato.stanford.edu/entries/ethics-virtue/ [accessed at 19th May 2009]

Virtue ethics, 2009, http://en.wikipedia.org/wiki/Virtue_ethics [accessed at 17th May 2009]