Question

Don Kim is a partner with a small firm which offers accounting and assurance services. He receives a call one day from Jane Small, his sister-in-law to ask if he would help out with a difficult situation. She explains that she has financial interests in a company called Intuition Ltd, and has been asked to contact him, as their previous auditor has resigned. The company needs an audit performed urgently to comply with various contractual and regulatory requirements and she is concerned that her money will be at risk if the audit is not completed within a month. She also confides that she is becoming increasingly concerned about the honesty and ethics of the directors. Don Kim impulsively accepts the audit engagement out of concern for Jane and promises to get started as soon as possible.

He soon regrets his impulsivity when he realises he has over-committed his small firm as all audit staff are already fairly heavily committed. He also realises that Intuition Ltd is a larger and more complex company than expected, with sophisticated computerised systems none of his staff have worked on before. Initial discussions with the managing director of Intuition Ltd reveal that he has little understanding of auditors’ responsibilities and is expecting significant assistance in addition to what is part of normal audit responsibilities.

2016 2017 Current ratio 2.2 : 1 0.4 : 1 Debt to Equity ratio 0.5 : 1 1.4 : 1 Accounts Receivable Turnover 26 days 80 days

Required: (Please read all three parts i.e., (a) – (c) below before starting your answer)

a) Briefly explain any four issues present in the scenario above that should have been identified and considered by Don Kim through proper client acceptance procedures before he accepted and commenced the audit of Intuition Ltd;

b) Proper client acceptance procedures require communication with the previous auditor prior to accepting a new audit engagement. Briefly explain why such communication is required as well as the necessary steps which Don Kim should have worked through to properly communicate with the previous auditor;

c) Briefly explain how and why the information from the analytical procedures will impact on the planning of the audit;

Answer 1

A. The following are the proper client acceptance procedures before he accepted and commenced the audit of Intuition Ltd:

1. Management Integrity :

The management environment can create business and audit risks that should be squarely addressed. The independent auditor, for example, examines financial statements that are based upon assertions of management ranging from the existence of an element in the financial statements to disclosures of information regarding that element. No responsible practitioner would knowingly place reliance on assertions of a client's management which had questionable integrity.

2. Relationships with Other Professionals:

An Auditor communicate with the predecessor auditor prior to committing to provide audit services to a new client. Matters of interest include the opinions issued by the predecessor auditor, resignation of the prior auditor or the refusal to stand for reelection, disagreements between the prior auditor and management regarding accounting principles or auditing procedures, and any "opinion shopping" issues. Inquiry of other professionals having dealings with the client should, however, not be limited to the predecessor auditors.

3. Risk of Association:

A prospective client should be engaged in legitimate business activities that do not violate the laws of the jurisdiction where the company is headquartered or carries on its business. Financial stability and liquidity of the prospective client also are important. Stability and liquidity can affect choice of auditing procedures and the report ultimately rendered. A prospective client with liquidity problems, an inability to meet its financial obligations when they are due, large numbers of transactions with related parties, and dependence upon a single customer or a small group of customers should be carefully considered prior to acceptance.

4. Technical Competence:  A basic tenet of auditing is that the work is to be performed by persons having adequate technical training and proficiency. Complexities of the modern business world add a dimension to this requirement that goes far beyond the technical aspects of auditing. Obviously, he must have the necessary technical competence to perform the required work or risk potential liability or damage to reputation

These are the issues he should make sure before he commited to audit the firm.

B. In the current business environment, certain client acceptance and continuance procedures are required by the auditing and assurance standards.A client acceptance and continuance form should contain basic information about an entity's business and environment, including a description of its applicable financial reporting framework. For entities using special purpose frameworks, the auditor should work early in the pre-engagement planning process to obtain documentation supporting the framework and become familiar with the specific policies and procedures applied by the entity.

A successor auditor communicate with the predecessor auditor prior to committing to provide audit services to a new client. Matters of interest include the opinions issued by the predecessor auditor, resignation of the prior auditor or the refusal to stand for reelection, disagreements between the prior auditor and management regarding accounting principles or auditing procedures, and any "opinion shopping" issues. Inquiry of other professionals having dealings with the client should, however, not be limited to the predecessor auditors.

C. Analytical procedures consist of ‘evaluations of financial information through analysis of plausible relationships among both financial and non-financial data’. They also encompass ‘such investigation as is necessary of identified fluctuations or relationships that are inconsistent with other relevant information or that differ from expected values by a significant amount.

Analytical procedures are used throughout the audit process and are conducted for three primary purposes:

1.  Preliminary analytical review

2. Substantive analytical procedures

3.Final analytical review

To obtain audit evidence, the auditor performs one – or a combination – of the following procedures:

• inspection
• observation
• external confirmation
• inquiry
• reperformance
• recalculation
• analytical procedures.

It is mandatory that the auditor should perform risk assessment for the identification and assessment of risks of material misstatement at the financial statement and assertion level, and the risk assessment procedures should include analytical procedures. It is also mandatory that the auditor should perform analytical procedures near the end of the audit that assess whether the financial statements are consistent with the auditor’s understanding of the entity.