Case study

You have just been appointed as a junior with Zulu Partners, an audit firm.

Zulu Partners is in reality a sole practitioner, Mr Smith, who has been auditing businesses in the

local town for 50 years. He is considered by locals to be a very nice man with a strong reputation for

honesty.

In late April, the firm is approached by Mr Bill Drake, the Chairman of the Board of Property

Developments (PD) a wholesale business with three warehouses to conduct the audit of PD. Mr

Drake explains that the previous auditor was too expensive, and they are looking for a more

economical audit. Mr Smith asks you to undertake the preliminary review.

As part of your review of PD you undertake enquiries of businessmen in the neighbourhood. There

is nothing directly adverse known about PD, however there is a rumour that is circulating that Mr

Drake ran a toy store for some years in another state. Further enquiries indicate that this toy store

failed about fifteen years ago, and ASIC barred Mr Drake from holding a company directorship for 6

years.

On behalf of Mr Smith, you approach Mr Drake to obtain a letter of authority to the previous

auditor to discuss the audit history with you. Mr Drake explains that he is so disappointed with the

previous auditor, that he will not correspond with him at all. On being told this Mr Smith says the

previous auditor was an expensive clown and "We can do much better job than him, I will accept

the audit!"

Address following issues

Ethics: The importance of independence and the threats:

The steps of an Audit:

1. Appointment - Engagement Letter

2. Planning:

Purpose: To prove management's assertions - So Know the Assertions!!!

Collection of evidence:

Step 1 An analytical review to see if there are any glaringly obvious areas that do not match expectations.

Step 2 Prove the control system

Then Step 3 Substantive testing (NB Analytical review is substantive happens 2 times beginning and end of Audit)

Finalizing and review - Solicitors letter, Management Letters and Post Balance date events.

Reporting

Let us look at analytical reviews:

what accounts fit into basic ratios to understand what discrepancies in the analytical review answers mean in terms of account balances at risk.

For example a quality leader, who would have a high mark up, would not be expected to have a high inventory turnover ratio, as they make more money per item than a price leader would. Which accounts become important here. Go and investigate the ratio stuff, and which accounts would be at risk when things do not make sense!

How the Audit risk model fits into this, and the types of evidence

AR = IR x CR x DR

The control testing measures CR and therefore guides the desired level of DR which guides how much substantive evidence is required to get that desired DR - This therefore drives audit strategy ant both the macro and micro level.

Types of evidence:

Quality of Evidence: Totally External v External circulated internally v Internal circulated externally v Internal.

Confirmations - 3 types: Reply direct to auditor with details. Reply direct to auditor confirming information. Reply direct to Auditor only if wrong.

Finalising the report:

Management letter confirming all oral representations

Letter(s) to management - independence, internal controls, other observations.

Post balance Events - Type 1 clarification - adjustment, type 2 is new - note. Note the timing and nature of the event is important here.

Audit report:

Statement of Audit responsibilities/management(directors) responsibilities

Statement of Key Audit Matters

Unqualified - with emphasis of matter, or other mattersno material problems

Other Audit matters - now required but similar to emphasis of matter

Qualified - Except for - minor scope limitation/disagreement with management that is material

Adverse - major disagreement with management

Inability to form an opinion - major scope limitation

What happens if the auditor fails to pick up something he should have - recall and reissue.