ACCM4400: Solutions – Workshop 2
Pre-Workshop Questions
Prior Knowledge Check Questions
Look for an audit report of a company online. Is the auditor guaranteeing anything? If yes, what is
the auditor guaranteeing? If not, why not?
Solution
The auditor does not guarantee anything. The auditor only gives a reasonable assurance that the
financial statements give a true and fair view. Reasonable assurance is a high degree of assurance
but is not absolute assurance.
The auditor also does not give assurance on the future viability of the company. The assurance being
given is on the financial reports and that it is prepared on a going concern basis; not the viability of
the company.
The auditor also does not guarantee that there is no fraud in the client organisation.
Misconceptions about what should be expected of an auditor is referred to as the "Expectation Gap"
The reason why the auditor cannot give a guarantee is that there is a limit to the time and cost an
auditor can spend on an audit as well as the nature of financial reports which includes the use of
judgement and estimates. Also, the nature of fraud is such that it can be very difficult to discover.
Additional Question 1
Do you think any of the users (shareholders, potential investors, lenders, government, customers,
employees, etc.) have the right to sue auditors for damages suffered due to reliance on audit report?
If yes, which users would this be?
Solution
The audit report is prepared for the shareholders. Therefore, the auditor is liable to shareholders for
negligent conduct. When it comes to 3rd parties (i.e. those other than shareholders), the requirements
have changed over the years. Currently, it would be very difficult for users other than the
shareholders to successfully sue auditors for damages.
Third parties can sue the auditor under the law of tort and will need to prove: Duty of care was
owed, there was a breach of duty of care and loss suffered was a consequence of the breach. It is
very difficult to prove that a duty of care was owed to third parties. The courts examine whether the
report by the auditor was meant to induce the third party to undertake specific actions in order to
establish duty of care.
Source for questions not developed by KBS are included after the respective question. Solutions
are developed by KBS.
ACC4400 Solutions
Workshop 2
Additional Question 2
What are the components of the audit expectation gap? Explain each component and give examples
where appropriate.
Solution
The three components of the audit expectation gap are:
1. Unreasonable expectation- this is caused by unreasonable expectation of users. Examples of
unreasonable expectations include:
a. An auditor provides complete assurance
b. An auditor guarantees the future viability of an entity
c. Auditor will uncover all fraud
d. Auditor checks 100% of transactions
2. Deficient performance – this exist when the auditor does not apply professional competence
and due care.
3. Deficient standards – this exists when the auditing standards guiding auditors are not at the
standard required or is not current with changes in the reporting environment.
Source for questions not developed by KBS are included after the respective question. Solutions
are developed by KBS.
ACC4400 Solutions
Workshop 2
During Workshop Questions (Class Activity)
Class Activity 1
1.
Why are audits of financial reports needed?
2.
Are shareholders the only group that relies on audited financial statements?
Solution
Audit services are needed as users may not have confidence in the financial reports prepared by
management which have not been audited. Some believe that management would be motivated to
show better than actual results in order to make themselves look better. (agency theory). Users also
use financial reports to make important decisions on the allocation of scarce resources. Because of
this, users will want more reliable information (information is assumed to be more reliable as it is
audited by an independent party i.e., the auditor).
Users do not have the training, knowledge or the expertise required to carry out the audit of financial
statements. Users also do not have access to information that is necessary to determine the credibility
of financial statements. Therefore, users rely on auditors.
Audit reports are prepared for the shareholders, but other users such as lenders, suppliers, customers,
employees, government, etc that would also rely on audited financial statements.
Class Activity 2
1. Why is independence so important for an assurance engagement?
2. Which form of independence (independence of mind or independence in appearance) is more
important in ensuring the usefulness of an assurance report?
Solution
1. If the assurance practitioner is not independent, the credibility and reliability of the assurance
report is questionable.
2. If the assurance practitioner does not have Independence of mind, the assurance practitioner
might be unduly influenced when forming a conclusion and may issue an inappropriate
conclusion instead of a correct conclusion in the assurance report. Users who rely on the
inappropriate conclusion might make inappropriate decisions that can lead to substantial
economic losses. This defeats the purpose of an assurance report.
If the assurance practitioner does not have independence in appearance. i.e., users do not believe the
assurance practitioner is independent, then even if the assurance practitioner carries out the
assurance engagement with utmost independence, users will not rely on the assurance report as the
users do not believe the assurance practitioner was independent in carrying out their duties. The
assurance report will then not have any value.
Therefore, without independence (both forms) assurance reports become totally useless.
Source for questions not developed by KBS are included after the respective question. Solutions
are developed by KBS.
ACC4400 Solutions
Workshop 2
Class Activity 3
Dolphin Surf & Leisure Holidays Pty Ltd (Dolphin) is a resort company based on the Great Barrier
Reef. Its operations include boating, surfing, diving and other leisure activities, a backpackers’
hostel, a family hotel and a five-star resort. Justin and Sarah Morris own the majority of the shares
in the Morris Group, which controls Dolphin. Justin is the chairman of the board of directors of both
Dolphin and the Morris Group, and Sarah is a director of both companies as well as the CFO of
Dolphin.
In February 2020, Justin Morris approached your audit firm, Clarke Partners, to carry out the
Dolphin audit for the year ended 30 June 2020. Dolphin has not been audited before but this year
the audit has been requested by the company’s bank and a new private equity investor group, which
has just acquired a 20 per cent share of Dolphin. You know that one of the partners at Clarke Partners
went to school with Justin and has been friends with both Justin and Sarah for many years.
Required:
(a) Identify and explain the significant threats to independence for Clarke Partners in accepting the
audit of Dolphin.
(b) Explain any relevant and practical safeguards that Clarke Partners could implement to reduce
the threats.
Adapted from Moroney, R, Campbell, F & Hamilton, J (2020)
Solution
It is important to note that case studies can have a lot of information that is merely background
information and is not relevant to the actual question.
In this case, the main issue is the fact that one of the partners at Clarke Partners, went to school with
Justin and has been friends with both Justin and Sarah for many years.
The audit has been requested by the company’s bank and a new private equity investor group. These
are the intended user. Sarah and Justin are the responsible party. The assurance practitioner, in this
case the auditor must have both independence of mind and independence in appearance.
A familiarity threat is present due to the relationship mentioned and this threatens both types of
independence. The audit firm will need to put in place safeguards to bring this threat to an acceptable
level. The safeguards would include:
• Not allowing the partner to be part of the audit engagement team
• The partner should also not be involved in any other aspects of the audit or be in a position
to influence the audit team
• If the partner is the only one with the required skills to carry out the audit of Dolphin, then
the audit firm should decline from accepting the audit.
Source for questions not developed by KBS are included after the respective question. Solutions
are developed by KBS.
ACC4400 Solutions
Workshop 2
Class Activity 4
Read Recommendation 4.1 of the ASX’s Corporate Governance Principles and Recommendations
and other relevant sources to answer the following questions:
a)
b)
c)
d)
What is the recommendation for the composition of the audit committee?
What is the role of the audit committee?
Is it a requirement that listed companies have an audit committee?
How do you think the existence of an audit committee helps enhance auditor independence?
Solution
a) The composition of the audit committee should be as follows:
i. should have at least 3 members
ii. All members should be non-executive directors
iii. Majority of members should be independent directors
iv. the chair should be an independent director who is not the chair of the board of directors
b) The main role of the audit committee is
i. Oversee the corporate reporting process & ensure the integrity of the financial reports.
ii. They involve themselves in the appointment & removal of external auditor, audit
partner rotation, review reasonableness of audit fees, consider how provision of nonaudit services affects auditor independence, and overall independence and performance
of auditor
c) The top 500 listed companies must have an audit committee and the top 300 companies must
follow the guidelines relating to Audit Committees.
d) The audit committee discusses the general scope and timing of external audit work. Audit
Committees also act as a facilitator for the auditor to communicate with the board of directors
and the auditors, for example: discussing sensitive matters with auditors such as controversial
accounting issues, disagreements with management, and deficiencies in internal control. They
strengthen auditor independence by being an independent communication link between
management and auditors.
Source for questions not developed by KBS are included after the respective question. Solutions
are developed by KBS.
ACC4400 Solutions
Workshop 2
Class Activity 5
Arendelle Shopping Centres has borrowed heavily in recent years. The pressures of rapid expansion
have been felt within its finance department, and the chief financial officer (CFO) has begun to
make mistakes. The CFO neglected to reclassify some of its debts from non-current liabilities to
current liabilities following default on some terms of the contract with an international banking
syndicate, and omitted contingent liabilities from the notes to the accounts. The billion-dollar
mistakes were not detected by either the directors or the auditors, and the financial report and audit
report were published. Following discovery of the mistake, the shares in Arendelle Shopping
Centres lost value rapidly and the company was placed into liquidation.
Required:
Discuss the auditor’s liability for losses suffered by
(a) Arendelle Shopping Centres investors and
(b) other parties.
Adapted from Moroney, R, Campbell, F & Hamilton, J (2020)
Solution
Auditors need to provide reasonable assurance that the financial statements taken as a whole are
free from material misstatements whether due to error or fraud. If the auditor had reviewed the
contract with the international banking syndicate, the auditor would have been able to identify the
error. Not having done so would imply that the auditor did not carry out the audit work in
accordance with what would be required of an auditor in this particular situation.
a) Auditors can be liable to shareholders/investors through
i. the law of contract – not carrying out adequate audit procedures that would have
identified the error would appear to be in contravention of the terms of the engagement
letter
ii. the law of tort – the auditors owe a duty of care to the shareholders – this can be proved
through the existence of the engagement letter. The auditors appear to have breached
this duty of care by not carrying out adequate audit procedures that would have
identified the error. The shareholders did suffer losses which appear to be due to the
breach of the duty of care by the auditor.
Based on the above the auditor is liable for the losses suffered by the investors. Important to
take note that proportionate liability will apply here as the directors are also responsible for
not detecting the error.
(b) It is harder to prove that auditors are liable to other parties who may have relied on the audit
report. This is because third parties do not have a contract with the auditor and therefor need to
prove that the auditor owed the third party a duty of care. As per the Caparo case, auditors need to
prove the following:
•
•
the loss suffered is a reasonably foreseeable consequence of the defendant’s conduct
there is sufficient ‘proximity’ of relationship between the defendant and the pursuer,
and
• it is 'fair, just and reasonable' to impose a liability on the defendant.
(ACCA Students Study Resources, Auditor Liability: ‘Fair and Reasonable’ punishment?)
Source for questions not developed by KBS are included after the respective question. Solutions
are developed by KBS.
ACC4400 Solutions
Workshop 2
In Esanda Finance v. KPMG (1994), The High Court...determined that for a relationship of
proximity sufficient for duty, it was necessary that the provider of advice or information either
intended to induce the plaintiff to rely on such advice or in the absence of such an intention,
knew that his statement would be communicated to the plaintiff......specifically in connection
with a particular transaction.....and that the plaintiff would be very likely to rely on it for the
purposes of deciding upon that transaction. (O’Leary,C.,1998).
Based on the above, it is unlikely that other parties can prove reasonable proximity and therefore,
the auditor will not be found liable to other parties.
Class Activity 6
Andrews, Rubina & Associates is a small, but rapidly growing, audit firm. Its success is largely
due to the growth of several clients that have been with the firm for more than five years. One of
these clients, Tyler Trading Ltd (Tyler), is now listed on the ASX and must comply with
additional reporting regulations. Tyler’s rapid growth has meant that it is financially stretched and
its accounting systems are struggling to keep up with the growth in business. The client
continuance decision is about to be made for the next financial year.
The managing partner of Andrews, Rubina & Associates, Caitlin Lunge, has recognised that the
audit firm needs to make some changes to deal with the issues created by the changing
circumstances of its major client and the audit firm’s overall growth. She is particularly concerned
that the audit firm could be legally liable if Tyler’s financial situation worsens and it fails.
Required:
What should Caitlin consider when making the client continuance decision for Tyler for the next
financial year?
Adapted from Moroney, R, Campbell, F & Hamilton, J (2020)
Solution
Caitlin must consider the following in the client continuance decision:
1. Due to the growth of the audit firm along with the growth of its clients, the audit firm may
not have enough resources (staff, time) to meet the requirements of auditing Tyler Trading.
If the audit firm does not have adequate resources but undertakes the audit anyway, it is
likely that the audit cannot be carried out with professional competence and due care and
this could increase the risk of legal liability.
2. Tyler Trading is now listed on ASX – does the audit firm have adequately competent staff to
address the additional reporting requirements. If it doesn’t it would lead to the same problem
listed in point 1.
3. Would the current financially stretched situation of Tyler Trading lead to management acting
in an unethical manner? Caitlin must assess the integrity of management. If client lacks
integrity, there is a higher risk of intentional material misstatements and this would increase
the risk of legal, liability if the auditor is unable to identify the material misstatements.
4. Due to the growth of Tyler Trading, is there a self-interest threat from the audit firms
dependence on fees? If this self-interest threat exists, the auditors’ objectivity will be
impacted, increasing the risk of legal liability
Source for questions not developed by KBS are included after the respective question. Solutions
are developed by KBS.
ACC4400 Solutions
Workshop 2
After Workshop Questions
Question 1
Newport & Associates (Newport) is a large audit firm with clients located around Australia. During
April 2018, Newport was successful in obtaining a new client, Clear Diagnostics Ltd (CDL), which
is one of Australia’s leading providers of diagnostic imaging services and owns 30 diagnostic clinics
across Australia.
Prior to the appointment of Newport as the auditor of CDL for the financial year ended 30 June
2018, some preliminary analysis identified the following information:
• Alex Silver, one of the assistants at Newport intended to be part of the 30 June 2018 audit
team, owns shares in CDL. Alex’s interest is not material to him.
• Newport was previously engaged by CDL to value its intellectual property. The consolidated
statement of financial position as at 30 June 2018 includes intangible assets of $25 million,
which were valued by Newport on 1 March 2018, following CDL’s acquisition of another
diagnostic imaging company. The intangibles are considered material to CDL.
Required:
(a) Identify and explain any potential threats to Newport’s independence as CDL’s auditor.
(b) Explain what action Newport should take, if any, to eliminate any potential threats identified
in (a)
(c) Identify an appropriate safeguard that Newport could implement to reduce the risk of a
similar independence threat occurring in the future.
Adapted from Gay GE., and Simnett, R.(2018)
Solution
Situation 1
(a) Ownership of shares in an audit client gives rise to a self-interest threat due to financial
interest and lead to Alex Silver carrying out his work without objectivity and integrity.
(b) Alex Silver should either dispose of his shares or he should be removed from the audit team
and put in an audit team of a different client.
(c) Newport should require all audit staff to disclose share ownership in audit clients and this
disclosure should be reviewed before assigning staff to an audit team of a particular client.
Situation 2
(a) This situation gives rise to a self-review threat as the intangible asset previously valued by
Newport is included in the financial reports that are to be audited by Newport.
(b) Newport should either refrain from auditing CDL or an independent party should conduct
another valuation of the intangible asset.
(c) Newport should put policies in place to ensure that any prior non-audit engagement with a
potential audit client should be reviewed before acceptance of the client.
Source for questions not developed by KBS are included after the respective question. Solutions
are developed by KBS.
ACC4400 Solutions
Workshop 2
Question 2
Regional Assurance Partners (RAP) is a three-partner audit and assurance firm based in Sydney.
The three partners are Bob, Finlay and Shelley. RAP has been appointed as auditor of Exquisite
Accessories Limited (EAL), a metals processing firm. This is the first year that RAP is undertaking
the EAL audit.
The chief executive officer (CEO) of EAL is Ralph Trinket. Ralph’s wife is a well-known jewellery
designer who frequently produces pieces for fashion shows and other high-profile media events.
Ralph has been vocal about his wife’s successful jewellery business and has offered to source some
exclusive and limited-edition pieces for the audit team.
Owen Jackson, the CFO, and Bob have been friends for many years. Their families usually go on
holiday together once a year, and they frequently socialise with one another. Bob rates Owen very
highly as a CFO and he is confident that Owen will cooperate with the auditors.
Elspeth O’Keefe, a new audit manager at RAP, was previously employed by EAL, and she prepared
the EAL financial report for the period under audit.
Required:
(a) Identify and explain three threats to independence for RAP when performing the EAL audit.
(b) For each threat identified in (a), state what actions RAP needs to implement to eliminate or
reduce the threat to an acceptable level.
Adapted from Gay GE., and Simnett, R.(2018)
Solution
Threats to independence
1. Exclusive and limited-edition jewellery offered to audit team –audit team members should
not accept gifts from audit clients unless the value is trivial or inconsequential as this may
create a self-interest threat and a familiarity threat. APES 110 also states that if the purpose
of the gift is to influence the behaviour of the audit team (inducement), then the gifts
should not be accepted even if the value is trivial and inconsequential. It would appear that
in this instance the value is not trivial or inconsequential and therefore RAP auditors
should not accept the gifts.
2. Bob, the audit partner, has a close relationship with, Owen Jackson, the CFO of Exquisite
Accessories Limited (EAL). This might create a familiarity threat and possibly a selfinterest threat. Bob should not be involved in the audit of EAL and should not be in a
position to influence the audit. Seeing that this is a small audit firm with only 3 partners,
RAP needs to consider if Bob’s non-involvement with the audit of EAL is an adequate
safeguard to ensure that Bob does not influence the audit in any way. If it is not then RAP
should refrain from conducting the audit.
3. Elspeth prepared the financial report for the period under review, when she was employed
by EAL. As the current audit manager of EAL, Elspeth will be checking her own work.
Therefore, a self-review threat exists. Elspeth should not be involved in the audit of EAL.
Source for questions not developed by KBS are included after the respective question. Solutions
are developed by KBS.
ACC4400 Solutions
Workshop 2
Reference List
ACCA Students Study Resources, Auditor Liability: ‘Fair and Reasonable’ punishment? ACCA,
retrieved
21
March
2021,
<https://www.accaglobal.com/an/en/student/exam-supportresources/professional-exams-study-resources/p7/technical-articles/auditor-liability.html>
Accounting Professional and Ethical Standards Board 2018, APES 110 Code of Ethics for
Professional Accountants (Including Independence Standards) APESB.
Australian Securities Exchange 2019, Corporate Governence Principles and Recommendations,
ASX,
ASX
Corporate
Governance
Council,
retrieved
19
March,
<https://www2.asx.com.au/content/dam/asx/about/corporate-governance-council/cgc-principlesand-recommendations-fourth-edn.pdf>
Gay, GE, & Simnett, R 2018, Auditing and Assurance Services in Australia, 7th edn, McGraw-Hill
Education, Sydney.
Moroney, R, Campbell, F & Hamilton, J 2020, Auditing, 4th edn, John Wiley & Sons Australia,
Queensland.
O′Leary, C. (1998), "Auditors’ liability to third parties ‐ the door remains open", Managerial
Auditing Journal, Vol. 13 No. 9, pp. 521-524, retrieved 21 March 2021,
<https://www.emerald.com/insight/content/doi/10.1108/02686909810245938/full/html>
Source for questions not developed by KBS are included after the respective question. Solutions
are developed by KBS.
ACC4400 Solutions
Workshop 2