Question

SCENARIO-2

You are an audit supervisor of Star & Co, planning the final audit of a new client, Franker Construction Co, for the year ending 31 December 2019. The company specializes in property construction and providing ongoing annual maintenance services for properties previously constructed. Forecast profit before tax is RO 46 millon and total assets are expected to be RO 53 million which is much higher than the balance of previous years. The company has recently upgraded their website during the year at a cost of RO 1·1 million. Franker Construction Co’s Finance director has provided you with the following notes regarding the company -- A full year-end inventory count will be undertaken on 30 September at all the 15 building sites where construction is in progress. There is not sufficient audit team resource to attend all inventory counts. Franker Construction Co has also insisted on completing the inventory count as well as the audit work as early as possible so that they can release their audit report well before time. In the month of October, the company had installed a new software and had migrated the entire pay roll from the old system to new one. In line with industry practice, Franker Construction Co. offers its customers a fiveyear building warranty, which covers any construction defects. Customers are not required to pay any additional fees to obtain the warranty. The finance director anticipates this provision will be lower than last year as the company has improved its building practices and therefore the quality of the finished properties. Franker Construction had few warranty complaints with customers whose cases come for hearing in the next week. Franker is confident that they would win the case if the audit partner represents as the audit team had earlier helped in few compliance and internal control implementation and was well familiar with the case details. Star & Co is put in a dilemma as the audit fees and other consultation fees for the last 2 years is overdue.

The finance director has informed you that although an allowance for receivables has historically been maintained, it is anticipated that this can be significantly reduced this month. Information from last year’s management accounts of Franker Construction Co’s shows a material overdraft balance. The finance director has confirmed that there are minimum profit and net assets covenants attached to the overdraft. A review of the management accounts shows the payables period was 49 days for November 2019, compared to 92 days in December 2019. The finance director anticipates that things will improve, and the number of days will become less.

Question 3: - (based on Scenario 2) As an audit supervisor of Star & Co, Identify the ethical threats and risk associated with the client Franker Construction & Co. and suggest appropriate responses / safeguards

Answer 1

The ethical threats and risks associated with the client Franker Construction & Co are-

1. Cost allocation- The company has recently upgraded their website during the year at a cost of RO 1·1 million. This means that cost allocation should be accurately captured in capital and revenue expenditure.

2. Reliability of data- As the website was recently upgraded; there is no reliability of data. There is a high ethical threat that the data might not be recorded accurately. Hence, the accounting records might have risk of completeness and data accuracy.

3. Lack of auditing- There are 15 building sites where construction is in progress and there is not sufficient audit team resource to attend all inventory counts. This might result in potential threat of data accuracy. Only physical assets are included in the accounting records. If the building construction is not completed before the end of the year, then it would look as though the accounting records are overstated.

4. Risk of case loses- Franker Construction had few warranty complaints with customers whose cases come for hearing in the next week. Though the company is confident in winning the case if the auditor helps them with compliance issues, there is a high risk that the company might lose the case and might need to pay compensatory damages to the customers. In accounting, it is not a good practice to assume that the company would win as it is overvaluing the company. If there is a high probability of customer payment, then contingent liability disclosure would be a requirement for the firm.

5. Risk of recovery in receivables- The finance director has informed that although an allowance for receivables has historically been maintained, it is anticipated that this can be significantly reduced this month. This is anticipation and there is no accurate data. Accounting records that shows the probable receivables might be an overstatement if the allowances are not reduced in that specific month as mentioned by the director.

6. Data inaccuracy- Information from last year’s management accounts of Franker Construction Co’s shows a material overdraft balance. The finance director has confirmed that there are minimum profit and net assets covenants attached to this overdraft. However, a review of the management accounts shows the payables period was 49 days for November 2019, compared to 92 days in December 2019. This inaccurate data is an ethical issue as it is a violation to professional code of conduct if they are included in the accounting records.

Note- If you liked the answer, please give an up-vote, this will be quite encouraging for me, Thank you.