Case Study

Ruthies is a fast expanding firm of chartered certified accountants with a growing number of audit clients.

. In April 2011 the firm was approached by the directors of Jonp Limited and asked to act as the company's auditors. Ruthies' partners were surprised by the approach given that Jonp Limited is a well established company, with a new financial director (a young very recently qualified accountant - and the son of the managing director), apparently sound management and complex, sophisticated computer- based administrative and accounting systems. Further, they were aware that its auditors had been in place for quite a number of years. Typically, over recent years the company has reported annual pre-tax profits in the region of £2 million. Notwithstanding their surprise, having carried out their normal procedures prior to deciding as to whether to accept the audit appointment, after giving due consideration to all relevant matters the partners of Ruthies decided to accept the audit engagement and the firm was duly appointed.

The directors of the company own 70 per cent of the share capital of Jonp Limited and the balance is owned by an unconnected individual investor - who in addition to owning shares in the company, has provided secured loan funds to the company at (better than bank) very competitive interest rate terms. The investor currently has a loan of £500,000 outstanding from the company which is due for repayment ' on demand' (i.e. at any time - as soon as requested by the investor).

Jonp Limited sells high quality personal computers, television sets, digital versatile disc (dvd) players and a very broad range of associated accessories from eighteen retail stores located in separate towns across the United Kingdom. Each store also has a large workshop, from where large teams of engineers repair high quantities of personal computers, television sets and dvd players, brought in and collected after repair, by customers. The customers pay for the repair works, by cash, debit card or credit card on collection of their property. There are also separate teams of engineers based at each store employed to install television aerials supplied by the company. All engineers are paid weekly, receiving a basic hourly rate of pay and regular high bonus payments based on a very complex productivity scheme.

The audit engagement partner in charge of the audit of the financial statements of Jonp Limited for the year ending 31 December 2011 is Mr Rivers and he has been informed by the directors of the company that they have received an offer from a third party to buy all of the shares in the company. The final offer price will depend upon the company's trading results for the current financial year. It transpires that the directors of Jonp Limited, have, for some time, been looking to sell the company and have been taking measures to increase interest from potential suitors to purchase. These measures included the undertaking of an extensive repair, renovation and improvement programme of works since February 2011 on its stores and workshop premises.

In January 2011 , whilst working on the installation of a television aerial at a customer' house, an engineer suffered very serious injuries in a fall from the roof - a consequence of which is that he is now unable to work and is permanently retired. After taking legal advice the ex - employee is now threatening to sue the company for ' health and safety' negligence unless it settles his claim against it for £320,000. The company has denied liability and is contesting the claim on the basis that in the directors' opinion the employee would not have fallen if he had followed the company's health and safety procedures, when installing the aerial. On this basis the company has not made any provision in its annual financial statements for any payment to be made to the employee. The company has copies on file of all of the extensive correspondence including that between the employees' solicitors and its own solicitors. Mr Rivers has also been informed ( verbally by the managing director ) that in the event of a successful claim against the Jonp Limited, its health and safety insurance policy would not cover any liability as at the time of the accident, due to an oversight by the company in not renewing cover on a timely basis , the company was not insured in this regard at the time of the accident .

Mr Rivers decided that the audit team will, as required, adopt a risk- based strategy to the final audit and he has assessed the inherent risk associated with the audit as being ‘high'. When enquiring into the company's system of internal control he ascertained that during the months of June and July 2011 the manager and assistant manager at one of the company's larger stores had colluded in perpetrating a fraud against the company by misappropriating cash payments made by customers for repair works carried out. Both employees were subsequently dismissed from their employment with the company. Investigation revealed that they had simply over-ridden established internal controls to ensure that the sales transactions represented by these repairs were not recorded in the company's accounting records. Notwithstanding this incident, having ascertained and evaluated the internal control of the company Mr Rivers has assessed the associated control risk as being ‘low'. Now, in December 2011, he is preparing the strategy and detailed audit planning for the audit engagement..

In conversations with Mr Rivers about auditors and the external audit function generally, Charles Candy - the Financial Director of Jonp Limited, expressed the following views:

"It seems obvious that an auditor who possesses the personal attribute of good professional judgement will be a good auditor"

"We spend a lot of time and resources investing in the internal control of the company. Therefore, I don't see the point on your wanting to focus so much time and resources on it. In my view, given the obvious competence and integrity of our management team, your firm's approach to the audit should be to just accept that there are no deficiencies in our internal control and focus simply on carrying out substantive procedures - thus saving us a lot of money in audit fees ".

REQUIRED

a) Identify TEN significant matters that you would expect to have influenced Mr Rivers to assess as ‘high,' the inherent risk associated with the audit of the financial statement of Jonp Limited. You should explain the audit concern associated with each matter.
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b) Explain the audit procedures that your firm should carry out to obtain assurance about the amount of the provision if any that should be included in the company's financial statements, in connection with the ex-employee's accident.

c) Describe SIX typical control activities that you would expect Mr Rivers to have found when ascertaining the system employed for repairs to personal computers, television sets and dvd players by Jonp Limited. Such controls could cover for example physical security of items held for repair, job costing or completeness of recording in the company's accounting records. You should explain the objective of each control procedure described.

d) Explain why testing by the auditor for completeness of income in a company such as Jonp Limited would be considered to be more difficult and complex than testing for completeness of income in a similarly well controlled single site manufacturing company selling goods to a relatively small number of wholesalers on credit terms.

e) Discuss the validity of Charles Candy's comment about the determinant of a good auditor

f) Discuss the validity of Charles Candy's stated views about the how your firm should approach its audit of the financial statements of Jonp Limited.