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SOLUTIONS MANUAL
to accompany
MODERN AUDITING
&
ASSURANCE SERVICES
6th edition
Prepared by
Philomena Leung, Paul Coram, Barry Cooper and
Peter Richardson
© John Wiley & Sons Australia, Ltd 2015

Solutions manual to accompany Modern Auditing and Assurance Services 6e
© John Wiley & Sons Australia, Ltd 2015 8.2
Chapter 8: Client evaluation and planning the audit
Review Questions
8.11 List the steps performed by an auditor before accepting a new audit
appointment.
• Assess the firm’s competence to carry out the audit work.
• Obtain permission from the client to contact the outgoing auditor, refuse the
engagement if permission is not received.
• Communicate with the outgoing auditor to assess if there are any reasons why they
should not accept appointment.
• Outgoing auditor will seek permission from client to respond and reply.
• Incoming auditor reviews response from outgoing auditor for any issues that might
affect acceptance of the audit.
• Consider if any conflicts of interest arise by accepting the client.
• Determine the firm’s ability to use due care in performing the audit.
• Consider the integrity of management.
• Prepare a preliminary assessment of risk of accepting the client.
8.12 Identify applicable ethical considerations in accepting a new audit engagement.
Before accepting a new client the auditor should consider whether acceptance would create
any threats to compliance with the fundamental principles (APES 110). The auditor should:
• evaluate whether there are circumstances that would compromise his or her
independence such as the existence of personal or financial relationships with the
proposed client or any conflict of interest between the auditor or any existing client
and the proposed client;
• assess competence to perform the audit, especially the availability of the necessary
expertise relative to the nature of the proposed audit clients business or scale of
operations;
• determine the ability to use due care, especially with respect to the timing of the audit
work and the availability of competent staff to complete the work to the required
standard within the time available.
8.13 What are the benefits of audit planning?
Benefits include allowing the auditor to:
• Direct attention to the key areas for the audit.
• Identify and resolve potential problems efficiently.
• Identify the mix of skills required to respond to identified risks.
• Select, direct, supervise, manage, including reviewing the work performed by, the
audit team.
• Ensure the audit is performed in a controlled manner.

8.14 Discuss the contention that the engagement letter understates the auditor’s legal
responsibilities so as to discourage litigation.
See ASA 210. The contents of an audit engagement letter are based on factual responsibilities
of the auditor. However, it is quite possible that some users/managers may look at the
engagement letter and perceive it as an attempt by auditors to reduce their responsibilities.
For example, they may draw this conclusion when reading the letter and noting that only
reasonable assurance is provided by auditors and that management is responsible for
adequate accounting records and the internal control structure. However, users would be
incorrect in drawing this conclusion because the letter is a statement of factual
responsibilities and auditors cannot contract out of their responsibilities.
8.15 Discuss the steps involved in the audit planning process.
Planning an audit involves establishing the overall audit strategy for the engagement and
developing an audit plan, in order to reduce audit risk to an acceptably low level (ASA 300).
Planning starts with an understanding of the entity and its environment. Planning also
involves (1) setting materiality levels, (2) assessing audit risk and its components, (3)
obtaining an understanding of the internal control structure and then (4) developing a
preliminary audit strategy for significant assertions. Auditors should also perform analytical
procedures as part of the planning process as well as consider the risk of fraud.
8.16 What is the purpose of touring operating facilities and offices?
A tour of the operating facilities and offices is a significant help to an auditor in obtaining
knowledge about a new client’s operating characteristics. During a tour of the factory,
auditors should become familiar with the factory layout, the manufacturing process, storage
facilities and potential trouble spots such as unlocked storerooms, obsolete materials and
excessive scrap.
During a tour of the office, an auditor should become knowledgeable about the types and
locations of accounting records and computer processing facilities and the work habits of
personnel. An important by-product of both tours is the opportunity to meet personnel who
occupy key positions within the organisation. The auditor should document the information
obtained from the factory and office tours.
8.17 Explain the importance of analytical procedures and why auditors may also use
non-financial measures in these procedures.
Analytical procedures are an important for obtaining a more detailed understanding of the
entity and for identifying areas of potential risk. The procedures allow the identification of
unexpected relationships and other unusual items. These indicate areas of greater risk and the
auditors can plan for them accordingly. Auditors also use non-financial information in
performing analytical procedures as financial numbers may have been manipulated to show
normal relationships. Therefore, the use of non-financial information can help identify areas
of possible fraud when they identify unexpected relationships and fluctuations.

8.18 What are the auditor’s responsibilities in relation to fraud?
The activities that the auditor will carry out include procedures to:
• Identify and assess the risks of material misstatement due to fraud.
• Ensure the audit team is aware of the risks of fraud and their responsibilities in
response to those risks.
• Design and implement appropriate responses to the fraud risks identified.
• Respond to any fraud or suspected fraud identified during the audit.
8.19 Define the term ‘working papers’ and indicate their main function in auditing.
Working papers are not defined in the auditing standards which refer to audit documentation.
“Audit documentation” means the record of audit procedures performed, relevant audit
evidence obtained, and conclusions the auditor reached (terms such as “working papers” or
“work papers” are also sometimes used) (ASA 230).
So working papers may be defined as the records kept by the auditor of procedures applied,
the tests performed, the information obtained, and the conclusions reached in the
engagement. Working papers provide the principal support for the auditor’s report, evidence
that the audit was made in accordance with auditing standards, and a means for coordinating
and supervising the audit.
8.20 Identify the benefits of preparing audit documentation.
• Assists the audit planning processes.
• Demonstrates the audit was performed in accordance with
auditing standards.
• Ensures the appropriate direction and supervision of the audit team.
• Facilitates the appropriate review of audit work ensuring the accountability of audit
team members.
• Proves evidence is sufficient and appropriate to support the audit opinion.

Professional Application Questions
8.21 Risk of fraud
Following are a number of factors recognised by the auditor as having an effect on the
risk of fraud.
1. The company is vulnerable to interest rate fluctuations.
2. Management has significant financial interests in the entity.
3. Employees express dissatisfaction with the company and its treatment of staff.
4. Many asset values are based on significant estimates that involve subjective
judgements.
5. Management does not place a high priority on ethical standards.
6. Inadequate systems of authorisation and approval of purchase transactions.
7. Management shows an excessive interest in increasing the entity’s share price.
8. There is a high turnover of internal audit and information technology staff.
9. Employees ignore internal controls and do not focus on reducing risks of
misappropriations of assets.
10. The entity’s industry is highly competitive.
11. Employees anticipate future redundancies.
12. Management attempts to justify marginal or inappropriate accounting on the
basis of materiality on a recurring basis.
Required
For each of the foregoing risk factors, use the following codes to identify the risk
component that is most directly related to (a) fraudulent financial reporting or
misappropriation of assets and (b) incentives/pressures, opportunity or
attitude/rationalisation.
FFR = fraudulent financial reporting I/P = incentives/pressures
MA = misappropriation of assets O = opportunity
A/R = attitude/rationalisation
(a) (b)
1 FFR I/P
2 FFR I/P
3 MA A/R
4 FFR O
5 FFR A/R
6 MA O
7 FFR A/R

(a) (b)
8 FFR O
9 MA A/R
10 FFR I/P
11 MA I/P
12 FFR A/R
8.22 Evaluating Independence
Prior to the appointment of Burberry Partners as the auditor of WeCare for the 2015
financial year, some preliminary analysis has identified the following situations:
 One of the accountants intended to be part of the 2015 audit team owns shares in
WeCare. The accountant’s interest is not material to him.
 Burberry was previously engaged by WeCare to value its intellectual property.
The consolidated balance sheet as at 30 June 2015 included intangible assets of $30
million, which were valued by Burberry on 1 March 2015 following WeCare’s
acquisition of HealthyGlow. The intangibles are considered material to WeCare.
Required
For each situation above:
(a) Identify and explain the potential type of threat to Burberry’s independence (your
answer should take into consideration the independence of individuals as well as
the firm as a whole).
(b) Explain the action that Burberry should take to eliminate the potential threat
identified in (a) above.
Shares
(a) s.324CH(1) of the Corporations Act prohibits a financial interest in the company by
the auditor. APES 290.113 states that a self-interest, familiarity or intimidation threat
may be created if a member of the audit team, or a member of that individual’s
immediate family has a financial interest in the entity. This can be mitigated if the
person is not a senior auditor and if the interest is not material.
(b) The action taken if this is decided to be a problem is to get the person to sell the
shares or remove the person from the audit engagement.
Generally, the audit firms have taken a conservative approach in recent years and prohibited
shareholdings in clients.
Intangibles
(a) This work was undertaken before Burberry was the auditor so the restrictions
associated with non-audit services do not apply. However, this is the provision of an
accounting service which the firm will now have to audit so it creates a self-review
threat. The significance of this threat in relation to valuation services includes a
number of factors included in APES 290.176, such as materiality, involvement of the

client, subjectivity etc.
(b) To eliminate this threat or reduce it to an acceptable level, safeguards include:
• Having a member who was not involved in performing the valuation service
review the audit or the valuation work performed; or
• Making arrangements so that personnel providing such services do not
participate in the audit engagement.
8.23 Client evaluation
Dinfal Ltd is a company that manufactures a range of products for the electronics
industry. You work for a medium-sized firm of accountants, Ejo, Gam & Step. It is now
29 May 2015 and you have been approached by Dennis Launch, one of the directors of
Dinfal Ltd, to perform the financial report audit for the year ended 30 June 2015.
From your brief conversation with Dennis you establish the following:
Dinfal Ltd was set up by Dennis and his cousin Berty Drip, who are both directors
and each own 50% of the shares. Both Dennis and Berty consider themselves to be
entrepreneurs and have a range of experience in different industries. Since creating
Dinfal Ltd six years ago, the profits have increased very quickly, sales having nearly
doubled each year.
Dennis mentions that they left their previous two auditors due to differences of
opinion about accounting policies and accounting treatments for various transactions
including research and development expenditure.
Your firm has wide experience of the industry but no previous connection to the
company. You have explained to Dennis that there are certain procedures that need to
be followed before you can accept appointment as auditors. Dennis has indicated that
Dinfal Ltd is seeking additional financing and would like the audit to be completed as
soon as possible so that the audited financial report can be provided to the potential
financiers to prevent any delay in accessing additional funds.
Required
Highlight the issues that your firm should consider before accepting the appointment as
the auditor of Dinfal Ltd.
• Does the firm have the staff with appropriate skills to carry out the audit?
• Determine the firm’s ability to use due care in performing the audit.
• Are the staff available at what is likely to be a busy time for the firm?
• A check will need to be performed to ensure the firm has no connections with the firm
that would affect independence.
• The firm has clients in the same industry and should therefore ensure there are no
conflicts of interest.
• Permission should be sought to contact the previous auditors, the audit should not be
accepted if this is not received.
• Communicate with the outgoing auditor to establish if there are any reasons why you
should not accept appointment, review the response you receive from the auditors for
any issues that would prevent you accepting the audit.
• You should also ensure that the previous auditor has properly resigned.
• Obtain further details of the issues with the previous auditors, including the details of

accounting policies being followed.
• Review prior year financial reports and obtain copies of the most recent financial
information.
• Consider the integrity of management.
• Obtain further details of the finance being sought, who the potential financiers are
and how the financial report will be presented to them as part of any funding
application.
8.24 Audit engagement letters
You are a partner in an audit firm and your firm has just won the audit for Dezigns
Ltd, a company involved in marketing and development of brands for large companies.
As per the requirements in ASA 210 Agreeing the Terms of Audit Engagements (ISA
210), you prepare an audit engagement letter. It details the objective of the audit, scope
and nature of the auditor’s responsibilities, a statement that management is responsible
for the preparation of the financial statements and safeguarding company assets, and
details about the audit fee. The managing director of Dezigns Ltd is not very impressed
when he is handed the letter. He states:
‘My business is operated on trust and my word is my bond. I am not going to sign this
agreement because it is getting our relationship off on the wrong footing. I am
particularly offended by all of the details outlining my responsibilities — I think I know
what they are. However, I know you have certain business practices so I am prepared to
sign a contract outlining your audit fees.’
Required
Write a letter to the managing director answering his concerns and explaining why you
need a signed audit engagement letter.
The Managing Director
Dezigns Ltd
Dear Sir
We appreciate your concerns about the audit engagement letter and we are sorry if giving you
the letter has offended you in any way. However, please appreciate that the preparation of the
letter is in no way indicative of any lack of trust of you or your firm. The letter is prepared
because we are professional accountants and as such we are obliged to follow professional
standards to ensure that our work is at an appropriate standard. As per the requirement of one
of the auditing standards, (ASA 210) we are obliged to prepare an audit engagement letter
outlining a number of specific things. The audit engagement letter is therefore a fairly
standard document that is basically the same for most clients.
It is true that it does outline your responsibilities but it does not add to them in any way. It is
just a restatement of your responsibilities as they are outlined in the Corporations Act. It does
not just discuss your responsibilities though; it also goes into quite a bit of detail about the
audit process and what our responsibilities are as auditors. This is to make everything clear
from the start of our relationship and avoid any confusion if there are any problems at a later
date.

We would be pleased to talk to you in more detail about the contents of this letter at a time of
your convenience and we look forward to our future professional relationship with Dezigns
Ltd.
Yours sincerely
The Audit Partner
8.25 Planning the audit
Your client is Gateshead Pty Ltd, a large family-owned company which imports and
sells computer hardware products. You are planning the 30 June 2015 audit and, from
your enquiries of management, have obtained the information below.
1. In January 2015, Gateshead applied for and was granted a new loan. The
submission made to the bank stated:
 the current ratio was 0.90
 gross profit was up by 25% compared with that at the same time last year
 the debt-to-equity ratio was 0.40.
2. The bank agreed to the new loan but did enter into a loan covenant with
Gateshead. The covenant required that the company should not breach certain
ratios, and placed certain restrictions on dividends.
From audits you have conducted in previous years, you are suspicious about the validity
of the ratios discussed in the submission. You hear from one of Gateshead’s accounting
staff that the figures had been ‘gently massaged’ to obtain the required ratios.
Required
Discuss (referring to specific areas of the audit) the implications of this information on
your planning of the audit.
This information will affect the planning of the audit for the year quite significantly as a
result of the analytical procedures carried out (ASA 520). It indicates that there is a high risk
of balances within the financial statements being manipulated to ensure that the company
achieves the requirements of the bank covenant with regard to financial ratios. In particular,
the comment that figures have been ‘gently massaged’ should be a cause for concern.
Particular risks:
Industry – Computer hardware
Risk – Potential risk of obsolescence in the inventory held because it is a product that
becomes obsolete very quickly.
Loan – Current ratio requirements
Risk – The company may attempt to overstate current assets and understate current
liabilities to comply with the loan agreement. They may do this by not providing
for doubtful debts or overvaluing inventory. Accruals may not be completely
recorded.
Loan – Company has stated that the gross profit was increased by 25%.
Risk – There is a risk that the cut off for sales has not been properly effected. This

should be carefully reviewed in the audit at the year-end.
Loan – Debt to equity ratio
Risk – This is more difficult to manipulate, however the auditor should look for
potential misclassification.
It is important for auditors to evaluate the compliance of companies with financial ratios. The
implications of a lack of compliance may be quite severe for the company, including
potential going concern problems.
8.26 Planning the audit; analytical review
Tirthe Ltd sells a range of indoor and outdoor furniture by recycling and reinterpreting
old furniture and other wood, metal, glass and plastic products obtained from a variety
of sources such as derelict buildings, deceased estate auctions and so on. Revenue comes
from sales to the general public and businesses such as hotels and restaurants. Some
small items are collected by customers but generally goods are delivered by Tirthe Ltd.
The directors have reported that it has been another good year for the organisation and
that they expect the coming year to be successful.
The draft income statement for 2015 together with audited figures for 2014 are given
below:
30 June
2015
30 June 2014
(draft) (actual)
Revenue 536 994 617 140
Cost of sales (322 187) (302 788)
Gross profit 214 807 314 352
Other income — 7 186
Operating expenses
Administration (95 438) (92 064)
Selling and distribution (50 575) (79 933)
Finance costs (7 434) (7 623)
Profit/(loss) before tax 61 360 141 918
Required
You are planning the audit of Tirthe Ltd for the year ended 30 June 2015, discuss the
issues to be considered in your audit planning from the information contained in the
income statements.
Ratio calculations
Ratio Formulae 2015 2014

Gross profit margin Gross profit ÷ Net sales 40% 51%
Profit margin Profit ÷ Net sales 11% 23%
Times interest
earned
Profit before income taxes and
interest expense ÷ interest expense
9% 20%
Trend analysis
30 June
2014
30 June
2015
30 June
2015
Income statement items (actual) % (draft)
Revenue 617 140 (13) 536 994
Cost of sales (302 788) 6 (322 187)
Gross profit 314 352 (32) 214 807
Other income 7 186 (100) —
Operating expenses
Administration (92 064) 4 (95 438)
Selling and distribution (79 933) (37) (50 575)
Finance costs (7 623) (2) (7 434)
Profit/(loss) before tax 141 918 (57) 61 360
Net profit (decrease of 57%)
The change in net profit is a much a greater fall than the levels of turnover would suggest.
The profit margin has dropped from 23% to 11%. The reasons for this fall needs to be
investigated. A review of each item on the income statement, as discussed below, should
provide those answers.
Sales revenue (decrease of 13%)
There needs to be some investigation to the director’s assertion that it has been another good
year given that the draft income statement shows a fall in revenue. Specific attention may be
devoted to sales testing for completeness (for possible understatement of sales) and cut-off
for receivables to ensure sales have been recorded in the correct period.
Cost of sales (increase of 6%)
Cost of sales have increased when sales revenue has fallen. This may indicate occurrence
problems for purchases (overstatement) or cut-off problems relating to payables and
inventory. It may also indicate completeness problems for inventory quantities
(understatement).
Gross profit (decrease of 32%)
Gross profit margin has fallen from 51% to 40% this may indicate difficult trading conditions
which contradict the director’s assertion about it being a good year. Investigations into the
causes of the change are required, it maybe that there has been an adjustment to pricing
policy leading to reduced profit percentages.
Other income (none this year)
There is no other income this year, this may refer to interest income, or other investment
income. In which case this would indicate the downturn in trade has reduced cash balances or
other investment balances. A review should be conducted to establish the ability of the
company to meet liabilities as they fall due to assess the possible going concern risk - it

should be noted that it usually takes more than one year of reduced performance to create
going concern problems.
Administration (increase of 4%)
Admin costs are likely to be fairly fixed (or stepped) and therefore it might be expected that
admin costs do not change much unless there is a significant change in volume of trade.
Selling and distribution (decrease of 37%)
There has been a decrease in sales which may suggests fewer deliveries, it may also be the
case that reducing the spend on marketing may have led to the fall in sales. There is a
possibility that some costs have been incorrectly allocated to cost of sales - given the increase
in cost of sales referred to above.
Interest payable (decrease of 2%)
A small decrease in the amount paid would not indicate any significant risk. Levels of cash
balances, loans and overdraft levels would indicate the extent to which this expense appears
realistic.
8.27 Fraud risk
Cleanway Ltd is a public company that competes in the highly competitive market for
manufactured household products. The company is dominated by Rob Bigbucks, the
chairman and chief executive officer, who has guided the company since it was a private
company and has extensive influence on all aspects of company operations. Rob is
known to have a short temper and in the past has threatened individuals in the
accounting department with no pay rise if they failed to help him achieve company
goals. Furthermore, the company has extended its influence over customers and has
dictated terms of sale to ensure that customers are able to obtain desired quantities of
their most popular products. Bonuses based on sales are a significant component of the
compensation package for individual product sales managers. Sales managers who do
not meet sales targets three quarters in a row are often replaced. The company has
performed well up until a recent recession, but now the company is having difficulty
moving inventory in most product lines as retailers have difficulty selling in a down
economy.
(a) Identify the fraud risks factors that are present in the case above.
(b) Identify the accounts and assertions that are most likely to be misstated based on
the fraud risk factors noted in this case.
(a) Fraud risk factors are identified in ASA 240:
● High degree of competition in the market
● Domination of the Rob Bigbucks
● Threatened employees with no payrises
● Significant portion of sales managers salaries are paid in bonuses
● Sales managers who do not meet targets three quarters in a row are replaced
● The industry is in a recession and it is starting to affect the company
(b) The financial statement assertions are identified in ASA 500. The most significant threat
is to the occurrence assertion for sales. There is very significant pressure on the sales

managers and there is a high risk that they will take any opportunity to overstate sales,
particularly given that there is a recession.
However, there is also a broader threat of financial reporting fraud on other balances.
This is because of the threatening behaviour of Rob Bigbucks over the accounting
department to ensure that they help him achieve “company goals”. Given the recession,
company goals will be harder to achieve increasing the pressure on the accounting
department.
8.28 Planning
Needles and Glue Ltd is an online retailer of a broad range of art and craft products.
You are an audit senior at the firm Naylor Swit & Co and are planning the financial
report audit for the year ended 30 June 2015. Needles and Glue is a new client to your
firm and this is the first year end since you were appointed. The following information
was obtained from a meeting with the CEO, Barbara Wool.
The company has managed to ride a wave of renewed interest by younger people in
arts and crafts and the revenue for 2015 is approximately $3.2 million. This continues a
trend that has seen revenue increase by between 20% and 30% consistently for the six
years since the company was started by Barbara and her tennis partner Sandra Cloth
who is the COO. Profits in 2015 are $0.2 million and have not increased significantly in
four years despite the increased turnover. In 2016 there are plans to broaden the range
of products sold to include bedding, curtains and household furnishings.
Rapid expansion has put pressure on the company’s various systems, not least of
which is the online sales order system. Needles and Glue do not have their own in-house
IT function relying on Barbara’s sister Tabatha who is responsible for accounting, IT,
HR, payroll and general office management.
You are aware that in previous years errors had been detected at the audit stage,
partly due to IT system errors and partly due to Tabatha’s inexperience as an
accountant. Barbara and Tabatha are confident that any errors in the financial report
will be immaterial and not worth investigating given how busy they are with the
growing business.
As part of the growth of the business the company is looking to raise additional bank
borrowings to fund more warehouse space and invest in improvements to the IT
systems. Barbara has indicated that she needs the audit report signed before 18
September which is when she will be meeting the bank to discuss the details of the loan.
Required
Identify the issues that give rise to risks for the financial report audit you are about to
commence.
Risks to be addressed in the planning of the audit:
First year of audit
This is the first year that the firm has audited the financial report and given the risks outlined
below the audit team will need to be vigilant to ensure audit risk can be minimised. This may
involve including more senior and experienced staff on the audit team.
Going concern risk and over-trading

Rapidly increasing revenue without a similar increase in profits might indicate the risk of
overtrading. Overtrading creates a risk of running out of cash in spite of the increasing
revenue. The need for additional bank loan funding might also suggest that the cash reserves
of the business are under pressure.
Continued expansion and investment in the new warehouse and IT is likely to put more
pressure on cash reserves. Borrowings will require interest payments putting more pressure
on profits. With low profit levels there may be only limited ability to borrow, there is
therefore a risk that inadequate funds will be available for expansion.
With cashflow difficulties, suppliers may be paid late and some may stop supplying if agreed
terms are breached.
The audit risk is that going concern risks are not disclosed or that the financial report should
be prepared on a breakup basis.
Selling a new range of products
The new products being sold are different to the existing product lines. They may be sold to a
similar customer group but there is a risk that obsolete stock will remain in the balance sheet.
The audit risk is that stock is over-valued in the balance sheet where they should be written
down to net realisable value.
IT control systems
There appears to be poor internal controls which leads to a risk of undetected errors in the
financial report. There is a business risk that problems arise in meeting orders from customers
leading to lost revenue.
Bank financing
It is likely that the audited financial report will form part of the decision making process for
the bank in deciding whether to lend the company money. There is a risk that the bank might
look to sue the auditor if the bank suffers a loss from the non-repayment of the loan that
might arise if the financial report contained errors that the auditor did not detect.
8.29 Planning the audit
Alice is an audit senior for the accounting firm of Wong and Partners. In Alice’s
planning of the audit of Lincoln Traders Ltd for the year ended 30 June 2015, she asked
to review the minutes of board of directors meetings for the year to date. From her
review, she noted the following information.
Wong and Partners
Lincoln Traders Ltd
Planning
P–7
Prepared by: Alice
Date: 28/5/15
Notes from board of directors meetings for year to May 2015:
16/8/14 The board agreed to revalue land and buildings in its financial statements in accordance with a
property valuation recently undertaken at the company’s request. The effect would be to
increase their value by 50%.
17/10/14 The company took over one of its major customers during the year. This was not expected to
alter its trading relationship.
15/12/14 It was agreed that a new ‘bonus scheme’ would be implemented. This scheme would award
directors a bonus of a percentage of the profits for this year if they could exceed last year’s
profit figure by 20%.

16/2/15 It was agreed that construction should begin on a new factory for processing tuna. A
construction contract was approved and it was expected the work on the new factory would
commence before the end of March, at least three months before the end of the financial year.
17/5/15 The board agreed to make a large loan to one of the company’s subsidiaries in Fiji one month
before the end of the financial year. The loan did not have any security and no interest was
charged.
Required
Discuss the effect that each of the five noted items in the minutes of the board of
directors meeting will have on specific aspects of the audit plan.
Revaluation of land and buildings
This will require further work by the auditor in the non-current assets section of the audit
work program. The auditor should evaluate whether the directors have obtained the use of an
expert in making this valuation and whether the valuation is part of a normal policy of
valuations. The auditor will need to consider AASB 116 in performing the audit on this
section and ensure the revaluation is on the “class” of assets. The auditor should also evaluate
the materiality of the revaluation to consider whether he/she should obtain the services of an
independent expert to ensure that the valuation is not greater than recoverable amount. The
auditor should consider ASA 620 if an in independent expert is used.
Takeover of a major customer
This is of interest to the auditor because Lincoln Traders will need to consolidate the
company. The auditor should take extra care to ensure that intercompany transactions are
properly identified and recorded for elimination on consolidation. The auditor should also
take particular care to ensure that all intercompany balances are eliminated at the end of the
year. Any large transactions between the two companies around balance date should be
carefully reviewed to ensure that cut-off has been properly effected.
Bonus scheme
These schemes are popular to attempt to align shareholders’ interests with management's.
However, they raise some concerns for auditors in relation to profit manipulation. The auditor
should be careful to ensure that all provisions are properly stated, all liabilities are recorded
in the period, and that accounting policies are consistent with prior years. The auditor should
also be careful to ensure that all sales towards the end of the year are valid and that there are
no unusually large returns after balance date.
New factory
The auditor should ensure that all costs are properly accumulated at the end of the year for
the construction in progress of the new factory. The auditor should perform adequate work on
the ‘construction in progress’ account and should visit the construction site to evaluate the
existence of the factory and obtain an estimate of its percentage of completion. Depending on
the materiality of the factory, the auditor may want to consider using the work of an expert,
ASA 620.
Loan to subsidiary in Fiji
The auditor should firstly ensure that the loan is adequately disclosed in the accounts of the
subsidiary in Fiji. The auditor should then consider the collectability of the loan. This may
include a review of the draft financial statements of the subsidiary and discussion with
management in both companies. It should be carefully evaluated to ensure that the amount is

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