Nov 2020 Q5 b.
You are a Partner in Green & Co., a firm of Chartered Accountants, with specific responsibility for the quality of audits. Green & Co. was appointed auditor of Cleanup Co, a provider of waste management services, in July 2019. You have just visited the audit team at the head office of Cleanup Co. The audit team comprises an audit manager, an audit senior and two audit trainees.
Cleanup Co’s draft accounts for the year ended 30 June 2019 show revenue of GH¢ 11.6 million (2018 – GH¢ 8.1 million) and total assets of GH¢ 3.6 million (2018 – GH¢ 2.55 million).
During your visit, a review of the audit working papers revealed the following:
i) On the audit planning checklist, the audit senior has crossed through the analytical procedures section and written ‘not applicable – new client’. The audit planning checklist has not been signed off as having been reviewed.
ii) The audit manager last visited Cleanup Co. office when the final audit commenced two weeks ago on 1 August. The audit senior has since completed the audit of tangible non-current assets (including property and service equipment) which amount to GH¢ 600,000 as at 30 June 2019 (2005 – GH¢ 600,000). The audit manager spends most of his time working from Green & Co’s office and is currently allocated to three other assignments as well as Cleanup Co’s audit.
iii) At 30 June 2019 trade receivables amounted to GH¢ 2.1 million (2018 – GH¢ 900,000). One of the trainees has just finished sending out requests for direct confirmation of customers’ balances as at the end of the reporting period.
iv) The other trainee has been assigned the audit of the consumable supplies which includes inventory amounting to GH¢ 88,000 (2018 – GH¢ 53,000). The trainee has carried out tests of controls over the perpetual inventory records and confirmed the ‘roll-back’ of a sample of current quantities to book quantities as at the year end.
v) The audit manager has noted the following matter for your attention. The financial statements as at 30 June 2018 disclosed, as unquantifiable, a contingent liability for pending litigation. However, the audit manager has seen a letter confirming that the matter was settled out of court for GH¢ 450,000 on 14 September 2018. The auditor’s report on the financial statements for the year ended 30 June 2018 was unmodified and signed on 19 September 2018. The audit manager believes that management of Cleanup Co. is not aware of the error and has not brought it to their attention.
Required:
Identify and comment on the implications of these findings for Green & Co’s quality control policies and procedures. (10 marks)
View Solution
i) Analytical procedures
Applying analytical procedures at the planning stage, to assist in understanding the business and in identifying areas of potential risk, is enshrined in an auditing standard (ISA 315) and therefore mandatory. Analytical procedures should have been performed (e.g. comparing the draft accounts to 30 June 2019 with prior year financial statements).
The audit senior may have insufficient knowledge of the waste management service industry to assess potential risks. In particular, Cleanup may be exposed to risks resulting in unrecorded liabilities (both actual and contingent) if claims are made against the company in respect of breaches of health and safety legislation or its licence to operate.
The audit has been inadequately planned and audit work has commenced before the audit plan has been reviewed by the audit manager. The audit may not be carried out effectively and efficiently.
ii) Audit manager’s assignments
The senior has performed work on tangible non-current assets which is a less material (17% of total assets) audit area than trade receivables (58% of total assets) which has been assigned to an audit trainee. Non-current assets also appear to be a lower risk audit area than trade receivables because the carrying amount of non-current assets is comparable with the prior year (GH¢ 600,000 at both year ends), whereas trade receivables have more than doubled (from GH¢ 900,000 to GH¢ 2.1m). This corroborates the implications of (a).
The audit is being inadequately supervised as work has been delegated inappropriately. It appears that Green & Co does not have sufficient audit staff with relevant competencies to meet its supervisory needs.
iii) Direct confirmation
It is usual for direct confirmation of customers’ balances to be obtained where trade receivables are material and it is reasonable to expect customers to respond. However, it is already six weeks after the end of the reporting period and, although trade receivables are clearly material (58% of total assets), an alternative approach may be more efficient (and cost effective). For example, monitoring of after-date cash will provide evidence about the collectability of receivables (as well as corroborate their existence).
iv) Inventory
Inventory is relatively immaterial from an auditing perspective, being less than 2.4% of total assets (2018 – 2.1%). Although it therefore seems appropriate that a trainee should be auditing it, the audit approach appears highly inefficient. Such in-depth testing (of controls and details) on an immaterial area provides further evidence that the audit has been inadequately planned.
Again, it may be due to a lack of monitoring of a mechanical approach being adopted by a trainee.
This also demonstrates a lack of knowledge and understanding about Cleanup’s business – the company has no inventory, only consumables used in the supply of services.
v) Prior period error
It appears that the subsequent events review was inadequate in that an adjusting event (the out-of-court settlement) was not taken account of. This resulted in material misstatement in the financial statements to 30 June 2018 as the provision for GH¢ 450,000 which should have been made represented 18% of total assets at that date.
The audit manager has not taken any account of the implications of this evidence for the conduct of the audit as the overall audit strategy and audit plan should have been reconsidered. For example:
- the oversight in the subsequent events review may not have been isolated and there could be other misstatements in opening balances (e.g. if an impairment was not recognised);
- there may be doubts about the reliability of managements’ written representations if it confirmed the litigation to be pending and/or asserted that there were no events after the reporting period to be taken account of.
The misstatement has implications for the quality of the prior period’s audit that may now require that additional work be carried out on opening balances and comparatives.
As the matter is material it warrants a prior period adjustment (IAS 8 Accounting Policies, Changes in Accounting Estimates and Errors). If this is not made Cleanup’s financial statements for the year ended 30 June 2019 will be materially misstated with respect to the current year and comparatives – because the expense of the out-of-court settlement should be attributed to the prior period and not to the current year’s net profit or loss.
The need for additional work may have a consequential effect on the current years’ time/fee/staff budgets.
The misstatement should have been brought to the attention of Cleanup’s management when it was discovered, so that a prior year adjustment could be made. If the audit manager did not feel competent to raise the matter with the client he should have discussed it immediately with the partner and not merely left it as a file note.
QC policies procedures at audit firm level/conclusions
That the audit is not being conducted in accordance with ISAs (e.g. ISA 300 Planning an Audit of Financial Statements, ISA 315 Identifying and Assessing the Risks of Material Misstatement Through Understanding the Entity and Its Environment and ISA 520 Analytical Procedures) means that Green’s quality control policies and procedures are not established and/or are not being communicated to personnel.
That audit work is being assigned to personnel with insufficient technical training and proficiency indicates weaknesses in procedures for hiring and/or training of personnel.
That there is insufficient direction, supervision and review of work at all levels to provide reasonable assurance that audit work is of an acceptable standard suggests a lack of resources.
Procedures for the acceptance of clients appear to be inadequate as the audit is being conducted so inefficiently (i.e. audit work is inappropriate and/or not cost-effective). In deciding whether or not to accept the audit of Cleanup, Green should have considered whether it had the ability to serve the client properly. The partner responsible for accepting the engagement does not appear to have evaluated the firm’s (lack of) knowledge of the industry.
The staffing of the audit of Cleanup should be reviewed and a more experienced person assigned to its completion and overall review.