ACCA AAA (UK) Past Papers - B1bf. Typical Threats - ACOWtancy Textbook

You are a manager in Foo & Co, responsible for the audit of Grohl
Co, a company which produces circuit boards which are sold to

manufacturers of electrical equipment such as computers and
mobile phones. It is the first time that you have managed this
audit client, taking over from the previous audit manager, Bob
Halen, last month.
The audit planning for the year ended 30 November 2012 is

about to commence, and you have just received an email from
Mia Vai, the audit engagement partner.
To: Audit manager

From: Mia Vai, Audit partner, Foo & Co
Subject: Grohl Co – audit planning
Hello
I am meeting with the other audit partners tomorrow to discuss

forthcoming audits and related issues. I understand that you
recently had a meeting with Mo Satriani, the finance director of
Grohl Co. Using the information from your meeting, I would like
you to prepare briefing notes for my use in which you:
Discuss any ethical issues raised, and recommend the relevant

actions to be taken by our firm.
(8 marks)
Thank you.
Comments made by Mo Satriani in your meeting
Business overview
Grohl Co’s principal business activity remains the production of

circuit boards. One of the key materials used in production is
copper wiring, all of which is imported. As a cost cutting
measure, in April 2012 a contract with a new overseas supplier
was signed, and all of the company’s copper wiring is now
supplied under this contract. Purchases are denominated in a
foreign currency, but the company does not use forward
exchange contracts in relation to its imports of copper wiring.
Grohl Co has two production facilities, one of which produces

goods for the export market, and the other produces goods for
the domestic market. About half of its goods are exported, but
the export market is suffering due to competition from cheaper
producers overseas. Most domestic sales are made under
contract with approximately 20 customers.
Recent developments
In early November 2012, production was halted for a week at the

production facility which supplies the domestic market. A
number of customers had returned goods, claiming faults in the
circuit boards supplied. On inspection, it was found that the
copper used in the circuit boards was corroded and therefore
unsuitable for use.
The corrosion is difficult to spot as it cannot be identified by eye,
and relies on electrical testing. All customers were contacted
immediately and, where necessary, products recalled and
replaced. The corroded copper remaining in inventory has been
identified and separated from the rest of the copper.
Work has recently started on a new production line which will

ensure that Grohl Co meets new regulatory requirements
prohibiting the use of certain chemicals, which come into force in
March 2013.
In July 2012, a loan of $30 million with an interest rate of 4%

was negotiated with Grohl Co’s bank, the main purpose of the
loan being to fund the capital expenditure necessary for the new
production line. $2•5 million of the loan represents an overdraft
which was converted into long-term finance.
Other matters
Several of Grohl Co’s executive directors and the financial

controller left in October 2012, to set up a company specialising
in the recycling of old electronic equipment. This new company
is not considered to be in competition with Grohl Co’s operations.
The directors left on good terms, and replacements for the
directors have been recruited.
One of Foo & Co’s audit managers, Bob Halen, is being

interviewed for the role of financial controller at Grohl Co. Bob is
a good candidate for the position, as he developed good
knowledge of Grohl Co’s business when he was managing the
audit.
At Grohl Co’s most recent board meeting, the audit fee was
discussed. The board members expressed concern over the size
of the audit fee, given the company’s loss for the year. The board
members would like to know whether the audit can be performed
on a contingent fee basis.
Financial Information provided by Mo Satriani
Extract from draft statement of comprehensive income for the

year ended 30 November 2012
2012 draft 2011 actual
$'000 $'000
revenue 12500 13800
operating costs -12000 -12800
---------- ----------
operating profit 500 1000
finance cost -800 -800
---------- ----------
profit/(loss) before tax -300 200

======= =======
The draft statement of financial position has not yet been

prepared, but Mo states that the total assets of Grohl Co at 30
November 2012 are $180 million, and cash at bank is
$130,000. Based on draft figures, the company’s current ratio is
1•1, and the quick ratio is 0•8.
Required:
Respond to the email from the audit partner
Hide answer Marking guide Examiners report

»
Ethical issues
An audit manager of Foo & Co is being interviewed for

the position of financial controller at Grohl Co. This
creates a potential ethical threat. According to IFAC’s
Code of Ethics for Professional Accountants, familiarity
or intimidation threats may be created by employment
with an audit client.
The familiarity threat is caused by the relationship that
Bob Halen will have with the audit team, having worked
at the firm. This may cause the audit team to lose
objectivity, fail to challenge him sufficiently and lose
professional skepticism.
The more junior members of the audit team may also

feel intimidated by him as his previous position was as
audit manager. He will also be aware of the firm’s audit
methodology and procedures, making it easier for him
to circumvent procedures.
IFAC’s Code states that if a former member of the audit

team or partner of the firm has joined the audit client in
a position that can influence the preparation of the
financial statements, and a significant connection
remains between the firm and the individual, the threat
would be so significant that no safeguards could reduce
the threat to an acceptable level.
Therefore it is crucial that Foo & Co ensures that no

significant connection between the audit firm and Bob
Halen remains, for example, by ensuring that he does
not continue to participate or appear to participate in
the firm’s business or professional activities, and by
making sure that he is not owed any material sum of
money from the audit firm.
If a significant connection were to remain, then the
threat to objectivity would be unacceptably high, and
Foo & Co would have to consider resigning as auditors
of Grohl Co.
In the event of Bob Halen accepting the position and no

significant connection between him and the firm
remaining, the existence and significance of familiarity
and intimidation threats would need to be considered
and appropriate safeguards, such as modifying the
audit plan and changing the composition of the audit
team, put in place.
Any work that Bob Halen may have recently performed

on Grohl Co should be subject to review, as there may
have been a self-interest threat if Bob knew he was
going to apply for the role at the same time as
performing work for the client. However, as audit
planning has yet to commence, this may not be an
important issue.
Foo & Co should have in place policies and procedures

which require members of an audit team to notify the
audit firm when entering employment negotiations with
the client, as required by IFAC’s Code. The firm’s
policies and procedures should be reviewed to ensure
they are adequate and they may need to be
communicated again to members of staff.
Tutorial note: It is not certain or even implied that Bob
has deliberately tried to hide his intention to join Grohl
Co – but credit will be awarded where candidates
assume this to be the case. Equally, credit will be
awarded for comments recognising that it is
appropriate that Bob has been removed from the audit
team.
As to the comment regarding whether the audit can be

conducted on a contingent fee basis, this is not allowed
according to IFAC’s Code. Contingent fee arrangements
in respect of audit engagements create self-interest
threats to the auditor’s objectivity and independence
that are so significant that they cannot be eliminated or
reduced to an acceptable level by the application of any
safeguards.
The audit fee must not depend on contingencies such

as whether the auditor’s report on the financial
statements is qualified or unqualified. The basis for the
calculation of the audit fee is agreed with the audited
entity each year before significant audit work is
undertaken.
Conclusion
The audit of Grohl Co should be approached as high

risk, due to the number of business risks and risks of
material misstatement explained in these briefing notes.
An audit strategy must be developed to minimise the
overall level of audit risk, and strong quality control
procedures must be adhered to throughout the audit. In
addition, the ethical issue relating to Bob Halen must be
brought to the attention of our firm’s Ethics Partner as
soon as possible.
3 Question 3b - December 2012
You are an audit manager in Weller & Co, an audit firm which
operates as part of an international network of firms. Weller & Co
is facing competition from other audit firms, and the partners
have been considering how the firm’s revenue could be
increased. Two suggestions have been made:
1. Audit partners and managers can be encouraged to sell non-

audit services to audit clients by including in their remuneration
package a bonus for successful sales.
2. All audit managers should suggest to their audit clients that as

well as providing the external audit service, Weller & Co can
provide the internal audit service as part of an ‘extended audit’
service.

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You are a manager in Foo & Co, responsible for the audit of Grohl

Co, a company which produces circuit boards which are sold to

The audit planning for the year ended 30 November 2012 is

To: Audit manager

I am meeting with the other audit partners tomorrow to discuss

Discuss any ethical issues raised, and recommend the relevant

Grohl Co’s principal business activity remains the production of

Grohl Co has two production facilities, one of which produces

In early November 2012, production was halted for a week at the

Work has recently started on a new production line which will

In July 2012, a loan of $30 million with an interest rate of 4%

Several of Grohl Co’s executive directors and the financial

One of Foo & Co’s audit managers, Bob Halen, is being

Financial Information provided by Mo Satriani

Extract from draft statement of comprehensive income for the

2012 draft 2011 actual

revenue 12500 13800

operating costs -12000 -12800

operating profit 500 1000

finance cost -800 -800

profit/(loss) before tax -300 200

The draft statement of financial position has not yet been

Respond to the email from the audit partner

Hide answer Marking guide Examiners report

An audit manager of Foo & Co is being interviewed for

The more junior members of the audit team may also

IFAC’s Code states that if a former member of the audit

Therefore it is crucial that Foo & Co ensures that no

In the event of Bob Halen accepting the position and no

Any work that Bob Halen may have recently performed

Foo & Co should have in place policies and procedures

As to the comment regarding whether the audit can be

The audit fee must not depend on contingencies such

The audit of Grohl Co should be approached as high

3 Question 3b - December 2012

1. Audit partners and managers can be encouraged to sell non-

2. All audit managers should suggest to their audit clients that as

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