Question

Please answer a b c d e HP Foods is a private company that has been in operation for many years in Birmingham. Owing to a rising need to raise additional capital the shareholders have passed a resolution to convert the company into a public company and seek listing on the London Stock Exchange. You have been contracted to help the Directors to carry the resolution through. During your preliminary discussion with the Directors, you realised that they were not very conversant with the listing rules of the London Stock Exchange and you drew their attention to the establishment of an Audit Committee as a condition for listing on the London Stock Exchange. The Directors agreed to discuss the establishment of the Audit Committee at the next emergency meeting and invited you to be present.
	Required:
	a.	Recommend what should be the composition of the audit committee and describe its responsibilities to the Directors as prescribed by the UK Corporate Governance Code (2018).
Your firm has been the auditor of J. Hudson & Co, a listed manufacturing company based in the West Midlands, for a number of years. The engagement partner has asked you to describe the matters you should consider when planning the audit for the year ended 31 December 2020. During a recent visit to the company you obtained the following information: The company installed a new computerised inventory control system, which has operated from 1 May 2019. Since the inventory control system records inventory movements and current inventory quantities, the company is proposing: to use the inventory quantities on the computer to value the inventory at the year-end, and not to carry out an inventory count at the year-end. [CONTINUED] You are aware there have been reliability problems with the company’s products, which have resulted in legal claims being brought against the company by some local customers, and other customers refusing to pay for the products. The Chief Financial Officer and purchasing manager were dismissed on 1 July last year. A replacement purchasing manager has been appointed but it is not expected that a new Chief Financial Officer will be appointed before the yearend of 31 December 2020. The chief accountant will be responsible for preparing the financial statements for audit.
	Required:
	b.	Critically evaluate the reasons why it is important that auditors should plan their audit work before commencing an audit assignment.
	c.	Describe FOUR audit risks and explain the auditor’s response to each risk in planning the audit of J. Hudson & Co.
You are the partner responsible for the audit of Kingston Inc. for the year ended December 2019. The final audit has been completed and you have been asked by the audit manager to draft the audit report. The manager is aware that there is guidance for auditors relating to the audit report in ISA 706 Emphasis of Matter Paragraphs and Other Matter Paragraphs in the Independent Auditor’s Report. The manager has asked for your assistance in this matter.
	Required:
	d.	Define an ‘Emphasis of Matter paragraph’ and explain, providing examples, the use of such a paragraph.
	e.	Define an ‘Other Matter paragraph’ and explain, providing examples, the use of such a paragraph.

Answer 1

Answer 1

(a) Composition of audit committee

The Audit Committee comprises at least two (2)
members. According to the Charter of the Audit
Committee, the majority of the Audit
Committee members must be independent of the
Company and at least one (1) member shall be
independent of the Company’s significant
Shareholders

Responsibilities of audit committee towards directors :

The Board has approved a Charter for the
Committee. According to its Charter, the Audit
Committee shall assist the Board in its
responsibilities concerning
· monitoring and supervising the financial
reporting process
· monitoring the efficiency of the Company’s
internal control, internal audit and risk
management systems
· reviewing the Company’s corporate
governance statement
· monitoring the statutory audit of the
financial statements and consolidated
financial statements
· reviewing the internal audit charter before
submission to the Board for approval and
reviewing internal audit plans and reports
· evaluating the independence and
performance of the statutory auditor or audit
firm, particularly the provision of related
services to the Company which the Audit
Committee monitors and approves
· contacts with the auditor and review of the
reports that the auditor prepares for the
Audit Committee
· preparing the proposal for the AGM for the
resolution on the election of the auditor.

Answer 2

(b) benefits of an audit plan

• It helps the auditor obtain sufficient appropriate evidence for the circumstances
• It helps to keep audit costs at a reasonable level.
• It helps to avoid misunderstandings with the client.
• It helps to ensure that potential problems are promptly identified
• It helps to know the scope of audit program by an Auditor.
• it helps to carry out the audit work smoothly and in a well defined manner

(C) types of Audit risk and their consideration are as follows:

1) control risk

Control risk or internal control risk is the risk that current internal control could not detect or fail to protect significant error or misstatement in the financial statements.

Basically, management is required to set up and assess the effectiveness and efficiency of internal control over financial reporting to make sure that financial statements are free from material misstatements

Consideration by auditor :

The auditor needs to understand and assess the client’s internal control over financial reporting conclude whether those control could be relied on or not.

If the client’s internal control seems to be strong, then the audit needs to confirm if the control is worked by testing internal control.

There are certain ways that auditors could use to help them to minimize the control risks that result from poor internal control. For example, auditors should have proper risks assessment at the planning stages.

These risks assessment required auditors to understand not only the nature of the business but also internal control activities that link to financial reporting.

2) detection risk

detection risk is the risk that auditor fails to detect the material misstatement in the financial statements and then issued an incorrect opinion to the audited financial statements.

The common cause of detection risk is improper audit planning, poor engagement management, wrong audit methodology, low competency and lack of understanding of audit clients.

Detection risk is occurred because of the auditor part rather than the client part.

Consideration by auditor:

There are certain guidelines that could help auditors to minimize detection risks so that the audit risks are also subsequently minimized.

At the time planning, auditors should set the right audit strategy, employed the right audit approach, and having a strong strategic audit plan.

Those including having a good understanding of the nature of the business, the complexity of the business operation, the complexity of the client’s financial statements, and a deep understanding of the client’s internal control over financial reporting.

A clear understanding of audit objectives and scope of audit could help auditors to set audit approaches and tailors the right audit program.

Having a strong audit team could also help auditors to minimize detection risks.

3) Inherent risk

Inherent risk refers to the risk that could not be protected or detected by the entity’s internal control. This risk could happen as a result of the complexity of the client’s nature of business or transactions.

Sometime, that nature of business could link to the complexity of financial transactions and require high involvement with judgment.

The risk is normally high if the transaction or even involve highly with human judgment. For example, the exposure in the complex derivative instrument.

Consideration by auditor

Auditors required to assess those kinds of risks and set up audit procedures to address inherent risks properly.

For example, the auditor needs to set up a proper audit plan, audit approach, and audit strategy so that all relevance inherent risks that might affect the financial statements are identified and rectified on time.

Those include sufficient time for the audit team to work on the significant areas or having a member that has a deep understanding of the business as well as accounting transactions of the auditing financial statements.

In case auditor being aware that the potential client has high exposure to inherent risks, and auditor also know that the current resources are not capable to handle such client, the audit should not accept the engagement.

This procedure could help the auditor to minimize audit risks that come from inherent risks.

(D) Emphasis on matter paragraph (EOM)

Emphasis of Matter paragraph – A paragraph included in the auditor’s report that refers to a matter appropriately presented or disclosed in the
financial statements that, in the auditor’s judgment, is of such importance that it is fundamental to users’ understanding of the financial statements.

When the auditor includes an Emphasis of Matter paragraph in the auditor’s report, the
auditor shall:
(a) Include the paragraph within a separate section of the auditor’s report with an
appropriate heading that includes the term “Emphasis of Matter”;
(b) Include in the paragraph a clear reference to the matter being emphasized and to
where relevant disclosures that fully describe the matter can be found in the financial
statements. The paragraph shall refer only to information presented or disclosed in
the financial statements; and
(c) Indicate that the auditor’s opinion is not modified in respect of the matter emphasized.

When the Emphasis of Matter paragraph relates to the applicable financial reporting
framework, including circumstances where the auditor determines that the financial
reporting framework prescribed by law or regulation would otherwise be
unacceptable,11 the auditor may consider it necessary to place the paragraph
immediately following the Basis of Opinion section to provide appropriate context to
the auditor’s opinion.
• When a Key Audit Matters section is presented in the auditor’s report, an Emphasis of
Matter paragraph may be presented either directly before or after the Key Audit
Matters section, based on the auditor’s judgment as to the relative significance of the
information included in the Emphasis of Matter paragraph. The auditor may also add
further context to the heading “Emphasis of Matter”, such as “Emphasis of Matter –
Subsequent Event”, to differentiate the Emphasis of Matter paragraph from the
individual matters described in the Key Audit Matters section

(E) other matter paragraph

A paragraph included in the auditor’s report that refers to a
matter other than those presented or disclosed in the financial statements that, in the
auditor’s judgment, is relevant to users’ understanding of the audit, the auditor’s
responsibilities or the auditor’s report.

If the auditor considers it necessary to communicate a matter other than those that are
presented or disclosed in the financial statements that, in the auditor’s judgment, is relevant to
users’ understanding of the audit, the auditor’s responsibilities or the auditor’s report, the
auditor shall include an Other Matter paragraph in the auditor’s report, provided this is not prohibited by law or regulation;

When a Key Audit Matters section is presented in the auditor’s report and an Other
Matter paragraph is also considered necessary, the auditor may add further context
to the heading “Other Matter”, such as “Other Matter – Scope of the Audit”, to
differentiate the Other Matter paragraph from the individual matters described in the
Key Audit Matters section.
• When an Other Matter paragraph is included to draw users’ attention to a matter
relating to Other Reporting Responsibilities addressed in the auditor’s report, the
paragraph may be included in the Report on Other Legal and Regulatory
Requirements section.
• When relevant to all the auditor’s responsibilities or users’ understanding of the
auditor’s report, the Other Matter paragraph may be included as a separate section
following the Report on the Audit of the Financial Statements and the Report on Other
Legal and Regulatory Requirements.