AUDIT & ASSURANCE

Time allowed – 3 hours Total marks – 100

[N.B. – The figures in the margin indicate full marks. Question must be answered in English. Examiner will take account of the quality of language and of the manner in which the answers are presented. Different parts, if any, of the same question must be answer in one place in order of sequence.] Marks

1. (a) You are in charge of audit of Holiday Resort Limited financial statements which is a popular tourist destination. Your team have completed audit fieldwork. You and your team had a discussion meeting with General Manager regarding the identified exceptions. At the end of the discussion, General Manager of the resort (GM) appreciated the audit team for finding all the improvement areas and thanked the audit team for the hard work. As a token of appreciation, he offered you and the full team a free stay in the resort including complimentary breakfast and free access to amenities during any weekend of your choice. You know the resort is very luxurious and it is very expensive as well as difficult to book the resort during the weekend. What will you respond to the General Manager? 3 (b) You are engagement manager for the audit of Alpha Technologies Limited (Alpha). During the audit, your team members has notified you that management of Alpha has decided to dispose some fully depreciated laptops, desktops and Cars. Most of the times disposed assets are in workable condition or require minor repair. As per the general practice, Alpha first invites internal bidding from employees for the assets being disposed. Alpha only calls for public bid if any asset remains unsold after internal bidding. Accountant of Alpha asked your team whether they want to participate in the internal bidding. Your team members have expressed their interest to you and requested your permission to participate in the bidding for laptops and cars. How will you respond to your team members’ request? 3 (c) Examples of situations when the auditor’s independence may be impaired are: (1) Providing taxation services to the company and its auditors (2) Providing accountancy services, including preparing periodic management accounts and annual financial statements (3) Providing management consultancy, including advice on new systems and systems of internal control

Requirement: Describe how each of the situations listed above may compromise auditor’s independence, and the ways in which an audit firm can minimize the effect which the provision of other services has on independence. 6

(d) Mesh Apparels Ltd., a well-established garments manufacturing and exporting company where you have joined recently as financial controller, is owned by Habibur Rahman (40%), Mominur Rahman (35%) and Rashidul Huq (25%). Upon joining you identified that the company has documentation lacking specially in revenue and payable segments. The company has various bank loans amounting to Tk. 180 crore but revenue stream does not match fixed expenses. You came to know that Mominur Rahman who is the Chairman leads a flamboyant life. A few days after your joining suddenly Habibur Rahman who was the Managing Director of the company died of cardiac arrest. After MD’s sudden death Mominur took over all executive authorities of the company and invited Shafa Habib, who is the widow of Habib and who gave her properties as mortgage against bank loans, to join the company as MD only as a formality merely to sign loan related official documents.

In the first week after MD’s demise, the sales director (Chairman’s spouse) brings to you a cheque in settlement of the account of a major buying house. She explains that the cheque (which appears to clear the amount due) is in fact an overpayment, as the balance showing on the sales ledger is before allowing bulk discount (which is calculated retrospectively). The sales director shows you her calculations and the agreement as authorized by the board. The sales director states that the buying house’s Managing Director has come to collect the discount in cash. She says that this is not an unusual occurrence for some of the company’s better parties. It helps to maintain a good relationship with those parties, which leads to purchasing loyalty. Another benefit of this arrangement is that it gives the sales director regular face-to-face meetings with the senior staff of those parties. It also reduces the high charges that the bank makes for handling cash. Page 1 of 5

You ask the sales director why the customers prefer to receive a refund in cash, rather than simply pay the net amount needed to settle the account. She replies that it is not appropriate for her to question their motives.

In the second week the production manager gave you a panic call that the workers in the factory started agitation for demand of paying-off their wages and overtimes, which are pending for last two months. When you talked to the Chairman he advised you to pursue bank to release more fund to pay the workers. When you talked the bank manager straight forwardly said that no fund will be released until a trust worthy Accounts Receivables list is submitted to the bank. You also received a call from warehouse manager who informed you that there is significant mismatch between production data and actual physical inventory at the warehouse. At this issue your chairman advised you to launch an investigation against Rashidul Huq, who was salaried factory in-charge before being taken as shareholder and director.

The company received a letter from tax authority claiming huge pending tax and penalty. When you consulted with the company’s tax retainer for submitting appeal petition, he accepted that the company’s tax returns were submitted based on fake sales figures and using tampered vouchers so chances of winning the appeal is bleak.

The above situation led you to seriously confronting with ethical choices and moral dilemmas in the course of discharging your professional duties.

Requirement: In given situation above, what are the main ethical issues & the ethical choices and moral dilemmas you are confronting? What should be your responses to those ethical issues as an individual professional accountant? 8

2. (a) Paradise Limited is one of the oldest audit clients of your firm. You are engagement manager for the client and currently preparing for the audit of year end 31 December 2018. You have formed a team who has previous auditing experience with the client. Before starting any auditing activities, your team senior has informed you in private that there is a vacancy at accounts department of Paradise Limited and its management has approached him offering the vacant position as he had understanding of the business and accounting process of Paradise Limited. Your team senior has not yet decided whether to accept the position.

Requirement: Identify and explain the issues that have arisen in the above situation. 2

(b) An accountancy firm has previously used the services of an independent provider to conduct cold reviews of its completed audit engagements. However, the partners have decided to undertake in-house all aspects of monitoring the quality of audits carried out.

Requirement: Set out the objectives of conducting cold reviews which in-house system must achieve. 3

(c) A prospective auditor is required to write to the client's existing auditor to seek information which could influence his decision as to whether he may accept the auditor appointment. Give examples of relevant matters which could be within this letter and which would influence the prospective auditor's decision to accept the audit appointment. If previous auditor informs you that their fees for last audit engagement remains unpaid, should your firm accept the engagement? 4

(d) You are the engagement manager for the audit of a private commercial bank having a network of more than 150 branches, across the country. During a recent meeting, a member of the audit committee referred to an instance of irregularity in a branch, whereby the Branch Manager had extended credit to a close relative without following the bank’s credit disbursement procedures. The member criticized the auditors for their failure to detect such instances and bring it to the notice of management and audit committee. The engagement partner to the audit has advised you to justify your position in writing to the client.

Requirement: As an engagement manager, write a letter to the audit committee informing your point of view with specific references to the International Standards on Auditing, where applicable. 3

(e) Fieldwork for the annual audit of Greentec Textile Mills Limited (GTML) has been completed and the financial statements and the audit report are due to be signed next week. During the Page 2 of 5

concluding meeting with the client, the auditor was informed that a fire has destroyed all the raw cloth placed in the warehouse at the mill. About 60% of the destroyed cloth was purchased after the reporting date. However, due to certain defect in the insurance policy, the insurance company settled the claim by paying 80% of the amount of loss.

Requirement: State the audit procedures and actions that should be carried out by the auditor in the above situation. 3

3. (a) Walton Motors, produced by was established in 1977. Walton is the first motorcycle manufacturer of with different models of 80cc to 150cc motorcycle. The company exports products in different countries of the world. Ruhul Amin, Partner announced that your firm has just received the audit engagement letter of Walton Motors (WM) and instructed you to officially start the audit planning phase. You assigned Harun and Lima senior associates of the audit team with the task to gain an understanding of business of Walton Motors. They are in favor of jump start the field audit than gaining thorough understanding of the client beforehand. You came to know that the CFO of WM recently resigned and senior management would release him on satisfactory completion of financial audit. Thus, there is a pressure from the CFO for quick completion of the audit same as last year audit and internal control documentation.

Requirement: In your opinion what is the importance of a formal audit plan and what could go wrong if you do not plan your audit appropriately? 5

(b) Runner Automobiles Ltd. started its production of motorbikes in 2011 in Bhaluka and currently employs 888 people. It has more than 200 dealers across the country. It produces 80 per cent of the motorcycle components except the engine and some electronic parts. The company produces more than 40,000 units of motorbikes a year and controls more than 11 percent of the domestic market. The plant makes motorbikes with capacities ranging from 80cc to 150cc at between Tk. 54,000 and Tk. 144,000. Its sales have been growing at 20 percent year-on-year.

Audit Manager Mijanur Rahman is preparing a report for the engagement partner of RAL. Rahman has been reviewing certain aspects of RAL’s business dynamics given the change in economic conditions over the past 12 months. Motorcycle sales year-on-year have risen nearly 25 per cent to 3.50 lakh units in 2017, after the government lowered the supplementary duty on imported parts and components of two-wheelers from 25 per cent to 20 per cent. The year 2017 was a boom period for the industry, in which 3.50 lakh units of motorbikes were sold and the forecast is that this will reach around 4 lakh units at the end of 2018 due to upcoming general election.

Runner Automobiles has beefed up its marketing efforts in Nepal in a bid to capture 15 percent of the growing motorcycle market in the Himalayan nation in the next five years. To this end, RAL recently appointed a distributor, Raman Motors, which is a subsidiary of Nepalese conglomerate Raman General. Raman has already appointed 11 dealers across the country to sell Runner motorcycles and plans to employ more and introduce after-sales services. During 2017 RAL has shipped 400 motorcycles of seven models to Nepal. Primarily, Runner has a target to send 3,000 units of motorcycles to Nepal every year.

Requirements: (i) Identify the issues that potentially have an impact on the audit of Runner Automobiles Ltd. 5 (ii) How do you develop a plan for successful audit by identifying the risks of financial statements misstatements that require closer examination? 5

(c) Tabassum a senior audit associate has drafted an audit plan for a new client Bangladesh Honda Private Limited (BHL), a Bangladesh-Japan joint venture company. Honda’s motorcycle business joint venture in Bangladesh is a new motorcycle factory on its own property in the Abdul Monem Economic Zone, Gazaria, Munshiganj. It will have an initial annual production capacity of 100,000 units of motorcycles with some special features like high speed, affordability and low CO2 emissions, and enhance customers’ satisfaction and efficiency in Bangladesh. In line with market trends, BHL plans to continue to invest in expanding its production capacity to 200,000 units by 2021, and will build its full-phase factory to accommodate future market growth. Honda has invested Tk.1.91 Billion in the new factory where its partner Bangladesh Steel and Engineering Corporation (BSEC) invested Tk.1.08 Billion. Total capital is Tk.3.6 Billion and Capitalization ratio is 70% Honda Group (Honda Motor Co., Ltd. and Asian Honda Motor Co., Page 3 of 5

Ltd.) and 30% Bangladesh Steel and Engineering Corporation. Its primary business will be import, production, and sales of motorcycles and parts. Earlier BHL had a small factory at Sreepur, Gazipur only for assembling the products but not worthy for manufacturing; and it showed more interest in imports than manufacturing.

Tabassum’s plan shows that audit time is divided to reflect this revenue pattern, i.e. 20 percent of the audit time will be spent on the import trade business and 80 percent of the time will be spent on the manufacturing. Tabassum believes that the significance of the revenue activities should be the only driver of the audit plan though the client has strong related parties but it has a simple, effective corporate governance structure.

Requirement: Being the engagement manager of the audit what additional points would you like to see before accepting the audit plan? 5

4. Your firm has been appointed as the auditor of Fresh Skincare Products Limited (Fresh) for the year ended 30 June 2018 and will be auditing Fresh for the first time. You have been assigned as the manager for the engagement. As part of understanding the entity, you have collected following information about business & operation of Fresh:

Fresh is one of the oldest and largest manufacturers of skincare products in Bangladesh. It has been operating successfully for more than two decades. It has its registered office in Dhaka and factory in Gazipur. Fresh has its own distribution channel which currently consists of one central depot annexed to the factory and 24 regional depots across the country. Business model of Fresh includes importing different chemical & acids as ingredients and produces skin care products in its own production facility. Finished goods are transferred to the central depot and subsequently dispatched to the regional depots. Fresh does not directly sell to the end consumers. It primarily sells to super shops and retailers who eventually sell to the end consumers with margin set by Fresh.

Fresh has implemented an Enterprise Resource Planning (ERP) software which contains several modules in order to synchronize and record purchase of raw material, production, movement of inventory, capturing sales order, generating invoice, recording sales and salary & wages data. ERP system compile all transactions and information in the form of ledger through accounting & finance module.

Fresh has a large sales promotion team who collects sales order from the retailers and records it the ERP system through their portable handheld devices or a mobile app. Super shops can directly place order in the ERP System. ERP system then automatically selects the nearest depot from where goods will be delivered. If goods are not available in the nearest depot, ERP system notifies the central depot. Central depot then delivers the good to that depot. However, in the case of emergency, central depot arranges delivery from the next nearest depot. The depot that is delivering the goods generates invoice. ERP records the sales against each customer name and updates sales & customer ledger. In the case of return, Sales promotion team initiates the return process and sales return is recorded in ERP only when depot receives the returned goods.

Procurement deportment issues purchase order based on the sales trend and forecast. Purchase orders and goods receipts are recorded through the ERP system. Purchase is recognized when goods are received at factory premises. Based on the information entered by the procurement team, ERP system records inventory purchase and updates inventory and supplier ledger. In the case of return of purchased goods, return is recorded when goods are returned by the procurement department.

At the time of production in factory, production department records raw material issues, production related expenses and quantity of finished goods. They manually allocate the overheads and assign cost per unit of finished goods. All these are then recorded in the ERP.

At the end of each month HR department accumulates monthly salary & wages payable and records in the ERP system. ERP system then updates the salary & wages expanse and payable ledger. Finance department then disburses the salary & wages and records the payment in ERP.

Accounts department then posts journals related to depreciation, expense provisions and finalizes the ledgers. A trial balance is generated by the ERP based on which accounts department prepares financial statements of the company.

None of the departments are aware of the information posted in ERP by another departments. Department heads are responsible for monitoring information entered by the employees of that department. All employees of the departments can access the ERP module related to their department.

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Requirements: (a) Explain why it is important for you and your team to have an understanding of the ERP system used by Fresh and take the ERP system into consideration during the audit? 2 (b) How the ERP system will impact in your audit strategy? Describe the procedures your team should perform related to the EPR system. 3 (c) Based on your understanding of the business, identify and explain the risks involving ERP System used by Fresh. Design procedures you will perform in response to the risks you have identified. 10 (d) Suggest the controls which Fresh should implement to reduce/ eliminate the risks you have identified. 5

5. (a) How will you evaluate audit evidence obtained to prepare the auditor’s report? What are the matters to be communicated with those charged with governance? 4 (b) Write appropriate audit opinions based on the following scenarios: 6 (i) As explained in Note 13, the company has not consolidated the financial statements of subsidiary XYZ Company it acquired during 2017, because it has not yet been able to ascertain the fair values of certain material assets and liabilities at the acquisition date. This investment is therefore accounted for on a cost basis. Under International Financial Reporting Standards, the subsidiary should have been consolidated, because it is controlled by the company. Had XYZ been consolidated, many elements in the accompanying financial statements would have been materially affected. The effects on the financial statements of the failure to consolidate have not been determined. (ii) We were not able to observe all physical inventories and confirm accounts receivable due to limitations placed on the scope of our work by the Company. We were unable to satisfy ourselves by alternative means concerning the inventory quantities and accounts receivable held at December 31, 2017, which are stated in the balance sheet at Tk. 25.00 crore and Tk. 30.00 crore respectively. As a result of these matters, we were unable to determine whether any adjustments might have been found necessary in respect of recorded or unrecorded inventories and accounts receivable, and the elements making up the income statement, statement of changes in equity, and cash-flow statement balance.

(c) You are manager of Shovon & Co. Chartered Accountants (SC). Following issues have arisen in three of your clients which are unrelated to each other.

Aquatic Limited Aquatic Limited (Aquatic) is a beverage company engaged in selling bottled drinking water. Its board of directors consists of 1 chairman, 6 directors and 3 independent directors. Aquatic is a subsidiary of Ocean Limited and Widespread Limited is a subsidiary of Aquatic. Ocean limited manufactures the bottled water for Aquatic and Widespread distributes the bottles across the country. Marketing director of Aquatic owns Bottle Label Limited which supplies bottle cap and label to Ocean Limited. In the financial statements, no disclosure has been made.

Orbit Limited Orbit Limited (Orbit) is a new client of your firm. You are auditing the financial statements of first year after incorporation. At the end of your audit. Your team has requested management to issue management representation. However, management of the company refuses to sign the management representation letter.

Blaze Limited Blaze Limited (Blaze) has reported purchase of a land in its financial statements under property, plant and equipment. Value of land is material for Blaze. While your team was going through the land purchase documents, your team members noticed that the land has been registered under the name of company owner Mr. Mamun instead of Blaze. In response to inquiry of your team, management has explained that it is not a big issue as Mr. Mamun owns the company and company will be using the land for constructing its factory.

Requirements: (i) Identify related parties of Aquatic Limited that should be reported in its financial statements. What additional information should be disclosed? 3 (ii) Help your team to identify risks from the above situations and design appropriate audit procedures to mitigate the risks. 9 (iii) What will be the audit opinion in respect of each of the items after completing your audit procedures? 3 Page 5 of 5