Case studies (25401/2E)24th Sept 2004

Question (1)

Bizarre Investments is an investment company. It is a private limited company with a staff of 300

There is a small internal audit department, focusing primarily on financial audits. Your firm provides external audit services and has been asked to bid provide internal audit a review services to Bizarre Investments, either on a partnership basis with the existing team or taking over the function completely.

(a)Describe the issues that you firm might face in the provision of internal audit services, in particular ethical concerns and how these could be addressed. (4 marks)

(b)Explain the advantages and disadvantages of outsourcing of internal audit services (6 marks)

Question (2)

ABC Limited would like to change the auditors due to the fact that the auditor had given a qualified auditors’ report for the past 3 years. The director of ABC Limited – Mr. Wong had refused to give explanations to auditors’ queries with regard to the channeling of funds from the company to its overseas subsidiary in Indonesia.

Mr. Wong would like to consult you (auditor senior of a CPA firm) on how he could remove the auditor from the current employment. (5 marks)

Mr. Wong stated that IRD has been reviewing the company’s tax position due to the issuance of a qualified auditors’ report. He wondered how he could stop the auditor from leaking information in relation to the company’s investment to the IRD. Mr. Wong would like to know the rights of auditors also (10 marks)

Class quiz on Lecture 1 (Auditing)Class : 25401/2E

Part I : Multiple choice

Choose the most APPROPRIATE answer

1. / The functions of an external auditor include
  1. To identity major weaknesses of the client’s internal control system and give recommendation
  2. To give an independent review and opinion of the client’s financial statements
  3. To help the client to develop its’ business
  4. To report any irregularities in the client’s business and report it the police if necessary

2. / Which of the following statement is TRUE
  1. An internal auditor is more important than the external auditor because the internal auditor could complete the audit procedures without the assistance of external auditor
  2. The HKSA imposes heavy penalties on those certified public accountants who had malpractice including imprisonment.
  3. The senior management of the company has the primary responsibility to ensure the financial statements are presented in accordance with GAAPs (Generally Accepted Accounting Principles)
  4. An auditor should be a man.

Part II : Fill in the blanks with the most suitable words:

  1. Nowadays, the resources allocations in the financial markets and within a corporation have become dependant to a very large extent on reports made by ____(police officers/management of the company/ shareholders of the company). Reliable ______(price/ cash/ information) is a must if managers, ______(government/charitable bodies/investors), creditors are to make economic decisions.
  2. Information risk is the risk that the ______(balance sheets/company/financial statements) distributed by a company will be materially false and misleading. This explains why an ______(dependant/independent/identifiable) review of the financial statements is so crucial to build up the credibility of the published information. This is especially true when the ______(minority/majority/tiny) interests have to be protected.
  3. There are several reasons for information risk:
  1. ______(quantum/marketability/accessibility) of information. It is difficult for all decision-makers to obtain firsthand information about the organization.
  2. Biases of the information ______(enjoyment/provider/preparer) When the information is obtained from others, the likelihood of it being intentionally or unintentionally misstated increases because there may be goal inconsistencies between the financial information users and the provider. The information may be biased in favour of the provider.
  3. Complex and ______(difficult/illegible/voluminous) data.
  1. Types of audit: Another name of external audit is ______(accounts audit/documented audit/financial statement audit)
  2. Another name of internal audit is ______(management audit/operational audit/book audit)

Part III : Comparison between internal auditor and external auditor in the following three aspects :

Internal auditor / External auditor
Determination of job scope / Vary widely and depend on the _s_____ and s____ and management requirements of the entity / Base on s_____requirements eg. Companies Ordinance, Statements of Auditing Standards issued by HKSA (SAS)
Objectives / Examine and e______on the adequacy and e____ of the accounting and internal control systems / Primary objective is to express an opinion on the t___ and f____ view of the financial statements. Secondary objective : detection of errors_ and f______
Line of reporting / Ideally, report to either or both Board of Directors and Audit Committee. / Audit report is addressed to s______of the company

Suggested answer

Question (1)

(a)The ethical issues have been particularly in prominence recently, with a body of opinion saying that external auditors should not undertake internal audit services because of the potential for conflict on interest and other obvious threat to independence. External auditors may be a position of reviewing the service provided by internal audit which is in effect a review of itself. This may inhibit both the role of internal and external audit.

Ways around his include

Companies clearly separating out the internal audit services away from the external audit activity with different group of staff and different line of reporting

An effective audit committee can provide a strong counter-balance to any ethical concerns, since they will be in a position to review both internal and external audit services.

Advantages of outsourcing

Greater focus on cost and efficient of the internal audit function

Broader range of expertise

Less vulnerable to high turnover or loss of staff

Short term needs can be met without incurring all year around costs

Disadvantages of outsourcing

Conflict of interests potential

Pressure on independence arising from the cost associated with the provision of internal audit. The outsourced department may experience pressure from management either through a threat not to renew the outsourcing contract or to pay all fees

Lack of close working knowledge of organizational business and culture

Conflicting objectives and culture of the outsourced service and the company receiving the service

Potential of increased cost or less time on internal audit

Question 2 : Please refer to lecture notes