Case Study and Report

Question 1 - Case

Jimmy Ford is an audit manager for Fitzgerald & Milhouse Chartered Accountants (F&M). Jimmy has been informed that the firm has plans to promote him to partner so long as he continues his good work. Jimmy has an array of talents that the firm admire. Jimmy has bought a new house, is a member of various clubs and generally confident about the future.

Jimmy is assigned to the audit of Engines International Ltd (EI), one of F&Ms biggest clients. EI use a questionable method of recognising revenues which has been investigated by ASIC. Jimmy concludes the method is not appropriate for EI.

Jimmy discusses the matter with the senior audit partner. The senior audit partner tells Jimmy that the method has been used for 10 years and is appropriate. The partner is also of the view that F&M will lose EI as a client if they are challenged about the use of this method.

Jimmy argues that while the method was okay in the past, the ASIC investigation has changed matters. Jimmy then tells the partner he accepts her decision but plans to include a dissenting statement in the audit working papers. The partner tells Jimmy she is not willing to permit such a statement, but that she is willing to write a letter to Jimmy acknowledging full responsibility for the audit.

The audit partner concludes by informing Jimmy that she is not comfortable with making him an audit partner and that he has growing up to do.

Required -

What should Jimmy do? Use the Code of Ethics for Professional Accountants and the American Accounting Association (AAA) Model to help consider your response to this question.

The best way to present your answer is in a table as below:

Question 2 - Report

You are the legal adviser to Kingsley Read, the external auditor of Plummet Travel Ltd. Plummet Travel promotes tours of New Zealand to Australians and owns a chain of duty-free shops. You have been auditing the company since it was listed on the Australian Stock Exchange (ASX) 10 years ago. Although the accounts have never been qualified, you are aware that the company has been making losses for the past three years as a result of short-term cash flow difficulties. The company has no long-term loans and the bank overdraft is near its limit at the end of the financial year.

During the financial year, the company upgraded its accounting system to a computer database. A consultant was hired to aid in the correct changeover of files for this system. At year-end, this new system had been in place for 6 months, and the director's report they are happy with the way in which it is operating. You do not have the expertise to review and evaluate the database management system, so you ask an independent expert to undertake this role. This person concludes that the system appears reliable and that the changeover was correctly carried out. You have never before audited this type of system, so you attend some courses to familiarise yourself with its features. Your firm has a standard work program that you use to test the controls operating within the system.

In your review of the minutes of the board of directors' meetings, you become aware that the New Zealand parent company (which owns 40% of the shares of Plummet Travel Ltd) is considering making an offer for the remaining shares. This is because the company's share price is trading well below its net asset backing.

After the audited 30 June 2016 financial statements are published, the takeover offer from the New Zealand parent company proceeds on the basis of an offer price equivalent to the net asset backing of $1.10 per share (as determined from the financial statements). The takeover results in acceptances of 96% of the issued capital, and compulsory acquisition proceedings have been instituted for the other 4%.

While these compulsory acquisition proceedings are being instituted, it is discovered that there were errors in the changeover of the computer system, which resulted in inventory at the duty free stores being materially misstated. After the subsequent write-down of inventory, a new asset backing of $0.70 per share is established. The New Zealand parent company is suing you for alleged negligence for its loss of $0.40 per share.

Required -

With reference to case law and the auditing standards, prepare a report to the managing partner of Kinglsey Read that indicates whether or not:

• Kingsley Read failed to exercise 'due care' in the audit of Plummet Travel;
• Plummet Travel is guilty of contributory negligence;
• Kingsley Read owes a duty of care to the New Zealand parent company.