Question 1:
Impulse Pty Ltd (Impulse) is an entertainment system manufacturer that was established in 2005. Your audit firm King & Queen have been the auditor of Impulse since its formation. The audit report for the year ended
30 June 2012 was unqualified. Although Impulse had been suffering liquidity problems with a drop in both debtors' turnover and inventory turnover, King & Queen did not consider that any additional audit work was necessary in regard to the valuation of these assets. In August 2012, Impulse obtained a large loan from a finance company, Easy Finance Limited (EFL), to provide additional working capital. However, Impulse continued to experience severe trading problems and was placed in liquidation in December 2012.
King & Queen has been notified by EFL's solicitors that they are taking action against your firm based on the audit of the 30 June 2012 financial report. EFL claim that the cause of Impulse's failure related to the inadequate provision for doubtful debts and a fall in the value of inventories on hand, and that these problems were evident at 30 June 2012, but had not been adequately dealt with in the financial report due to your negligence. They also claim that they would not have given the loan to Impulse if the 2012 financial report had been qualified.
Required
a) Would King & Queen be liable to EFL? Provide specific case references to support your answer.
b) Would your answer change if EFL had written to King & Queen advising you that they intended to make a loan to Impulse and were relying on the 2012 audited financial report to assist them in making their decision?
Question 2:
The following are independent situations:
(i) Bob is an audit assistant currently undertaking university studies. While auditing the books of Club Casino, he comes across certain financial information that he believes will assist him in completing one of his university assignments. He copies the information and uses it in his assignment, carefully removing all reference to Club Casino in order to preserve the client's confidentiality.
(ii) Wendy has been the engagement partner on the Ace Limited audit for a number of years. Some time ago, Ace's long-standing company secretary retired and Ace took six months to find a replacement. At Ace's request, Wendy performed company secretarial duties for this period of time.
(iii) Leo is the eldest son of the factory foreman of one of your firm's major audit clients, Precision Machinery Limited. During vacation work, L is assigned to the audit of Precision Machinery. Leo's work comprised testing the internal controls of the cash payments system.
(iv) Chan & Associates are auditors of Classic Reproductions Pty. Limited, a large furniture wholesaler currently experiencing financial difficulties. Classic Reproductions is a significant client of Chan & Associates and have not paid their audit fee for the past three years. The audit partner recently threatened to resign from the audit if the outstanding fees were not paid. To prevent this occurring, Classic Reproductions offered to supply Chan & Associates with new office furniture. The partner accepted this offer in full consideration of the outstanding fees, even though the furniture was only worth 50% of the balance. As a thankyou present, Classic Reproductions gave the partner a 25% shareholding in an unrelated listed company. At present these shares are worth $1,000. Chan & Associates do not act as auditors of this company.
Required:
a) Define actual and perceived independence, and explain the importance of each.
b) For each of the above independent situations list any professional standards and regulatory requirements breached and discuss possible alternative courses of action the auditor should have taken in order to properly discharge their professional responsibilities.