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EXECUTIVE TRAINING COMPANY(INTERNATIONAL) LTD

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www.etctraining.com.hk

About the Lecturer

Dr Fiona Lam Managing Director and Principal lecturer - ETC Training (MC,MD)

Ph.D, ACA(UK), FCCA, FAIA, CPA (Practising), BBA(Acc & Fin), ATIHK

• Practising partner of a medium size firm

• Practical experience in corporate governance, risk management, auditing

and tax

• Passed QP exams and other exams ie ACCA, AIA, PC all in one go

• Commenced teaching both MC and MD 8 years ago

• Taught over 4000 students

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Module Preparation SeminarTopics :• Identifying and assessing the risks of

material misstatement (HKSA 315 (Clarified)) LP Chapter 8 – Point 4-6

• Independence of auditors LP Chapter 4 – Point 2

• Going Concern LP Chapter 16 – Point 2

Module C Business Assurance

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What is Audit ?

Shareholders

Director Auditors

Investors invest Money

Appoint Auditors

Determine Auditor’s Fees

Obtain Sufficient + Appropriate Audit Evidence


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LOGOAudit Process


[HKSA 300 (Clarified)] Audit planningMandatory [MUST]

Effective+ Efficient Audit

Audit Planning

Set Materiality levels

Risk Assessment Toc

Responsibility to assessed risks

Overall review stage

Timing manner

Assign staff

Co-ordination

Focus on high risk areas

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1) Industry Listed->listing rules Special regulation ie SFC Stock broking (food/medicine/stock broking/licence) Multi-locations HK/Asia/US/Europe2) Product Special products (orders) Product life cycle->short/long Subject to HKAS->Impairment HKAS 16 PPE3) HKAS ->Property HKAS 40 Inv property HKAS 36 impairment loss ->Financial Instrument HKAS 32 and 39

Audit planning


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4) This year changes risks -Expansion->Industry expansion in market ->Product->new products introduced ->Group->acquisition of different subsidiaries - Changes in Management ie [Financial controller] -CEO[Consider re-assessing management integrity] -Accounting standards changes

Audit planning

More Changes = More Risks

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LOGOIdentifying and assessing the risks of material misstatement (HKSA 315 (Clarified))

LP Chapter 8 – Point 4-6

Examine in every examRead in conjunction with HKSA 330 (Clarified)

Risk Assessment


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• Understand the entity and its environment + *Risk Assessment

(Exam: Assess the Risk……)

HKSA 315(Clarified)


HKSA 330(Clarified)• Responses to assessed risks (Tests of controls+

Sub Testing) (Exam: Give responses to determine the Audit

procedures)

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Audit Risk “Wrong Opinion”

Inherent Risk CoControl Risk Detection Risk

No Internal control, risk still exists

Internal control exists but fails

Auditors fail to detect errors

Components of audit risk

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IR

-Industry-Competitiveness-Special regulations-Product->Cash sales- Economic factors


CR

- Special Control designed-Control environment-Authorisation-Physical controls

Combined assessment

All related to the client

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LOGOHKSA 315 Risk Assessment


Audit risk is the risk that the auditor expresses an inappropriate audit opinion when the financial statements are materially misstated. It is a function of the risk of material misstatement (inherent risk and control risk) and the risk that the auditor will not detect such misstatement (detection risk).

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HKSA 315 (Clarified) Risk Assessment


At Financial statement level

-> Net Asset-> Net Profit /Loss

i) FS as a whole Industry->Statement of Financial position ->Notes to accounts

ii) Pervasive to FS as a whole

iii) Affect many assertions

At Assertion level

Statement Of Financial Position

Ie. Investment property

Statement ofComprehensive

Income

Sales purchase Bad debt

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HKSA 315 (Clarified)Risk Assessment


At Financial statement level

(iv) Risks from a deficient control environment which includes management’s attitudes towards good internal control practice

(v) Aggressive business strategies

(vi) Complexity of business operation

(vii) Concern about the entity as a going concern

At Assertion level Not able to reduce the risks of

material misstatement to an acceptably low level with audit evidence obtained only from substantive procedures

Refer to specific classes of transactions, accounts balances

Complexity of underlying transactions

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FS LEVELGeneral Approach

-Assign more competent staff-More supervision-Collect persuasive evidence(general)-Maintain professional Skepticism-Use expert-Unpredictable procedures

HKSA 330 (Clarified)Responses to assessed risk


Assertion LEVEL

Test of control

Substantive testing

Enquiry , vouching

HKAS Specific procedures

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LOGO• Significant - Non-routine transactions• Many intervention ->Judgments deals with

transactions-data collection

Significant Risk


• Complex calculation -construction contracts -deferred tax -share-based payments -IC cannot capture• Accounting estimates – Significant estimates• Assumptions• Related to fraud• Responses MUST perform Tests of Controls

MUST perform Specific Sub Testing

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LOGOSignificant Risk

Examples :

•Regulated industries

•Legal claims

•Turnover – Aggressive revenue recognition

•Changes in group structures

•New Industries

•Shipping / Stockbrokers / Legal lawyers / Insurance brokers

Significant Risk


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LOGO• Computerised systems• Lack of audit trail• No sub testing; Increase Toc

Automation Risks


ITAudit Procedures

EExtenti)Quantityii)Sample

TRisky near to YIE

N Audit approachi)Combined approach Toc + Sub testing

ii) Substantive approach sub testing only

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Exam Techniques on Risk Assessment

Module C – in respect of external auditor FE - in respect of management

Read the question carefully to identify which question is asking to perform HKSA 315 (Clarified) – Must perform risk assessment

Students should be able to distinguish the risk of assessment at Financial Statement Level, Assertion level and Significant risk or Risk of material misstatement due to fraud

Consider whether you need to address the response to assessed risks


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Code of Ethics

Independence of auditors LP Chapter 4 – Point 2

Examine in every exam, either in One whole question in Section B; orPart of a question in client acceptance procedure in Section A


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Ethical RequirementCode of Ethics

PROFESSIONAL ACCOUNTANT

FUNDAMENTAL PRINCIPLES

Integrity

Honest & Straight Forward

Professional Competence

DUE CARE

ConfidentialityProfessional Behaviors

Not disclose

Unlawful Acts

Objectivity

Not biased

No Conflictof Interest

UNDUE Dependence

“Independence”

•Threats to independence

•Evaluate significance of threats

•Apply safeguards

Decline/Accept/Discontinue

+

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LOGOIndependence


Independence

S290

Independence in Audit + Review

Other than Audit + Review

Independence in mind + in appearance Perceived Independence

S291

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LOGOThreats to independence


5 Threats to independence

Self Review Threat

Review own work

Familiarity Threat

Closed rel’p

Too sympathetic to client

Advocacy Treat

in support of clientFinancial interest

Intimidation Threat

Threat to replace

Self Interest Threat

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LOGOSituations of Self interest threats


Gifts + hospitality

Significant value

Judgement

Equal to everyone

Conditions attached

Decline the offers

Consult senior/manager

Beneficial interest in client

Consider significance Dispose the shares Remove the person from

the engagement team Report to firm Inherit shares – dispose at

your earliest date

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Employment with client

when a professional accountant is employed by both an audit firm and a client entity.

The client’s finance director who has a background as an audit partner has too much knowledge of the audit firm’s systems and procedures .

“Cooling off” period

That a partner should not accept a key management position at any entity with which he has been involved until at least two years have elapsed since the conclusion of the audit with which he was connected.

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Overdue Fee

Loan to Client - Safeguards: settle fee

The firm or an individual on the assurance engagement should never enter into any loan or guarantee arrangement with an entity that is not a bank or similar institution.

Loans and Guarantees from client

Under normal commercial term Significance of the loan Decline the loan

Fees

Contingent Fee

Fee charged on basis [conditions]

Fixed fees no further safeguards

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Fees

A firm being concerned about the possibility of losing a significant client. The public may perceive that a firm’s objectivity is likely to be impaired where the fees for audit and recurring work paid by an entity or group of connected entities exceeds 15 per cent of the firm’s total fees. If the entity is listed or is otherwise deemed to be of public interest, this figure is lowered to 10 per cent.

Undue dependence on total fees

Where an audit client is a public interest entity and, for two consecutive years, the total fees from the client and its related entities represent more than 15% of the total fees received by the firm. In addition, pre-issue and post-issue reviews should be performed.

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Fees

Low balling

where a firm quotes a significantly lower fee level for an assurance service than would have been charged by the predecessor firm usually in order to gain other more non-assurance business.

A firm is entitled to charge a significant low fee for any reason but should be aware of the threat to objectivity this creates.

Significant low fee

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LOGOSituations of Self Review threat


Safeguards Segregation of duties separate

teams Independent partner to review Quality control policies Resign assurance engagement: audit

CPA

Audit +

Non-Audit Work

Not allowable

Authorize, execute, managerial decision

Create significant self review threat

Scenarios to apply :BookkeepingTaxationValuationInternal auditCorporate FinanceInternal Audit

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LOGOSituations of Self Review threat


CPA Firm

Public Interest Entities

Firms should not prepare accounts or financial statements or any other non-assurance work for listed or public interest entity, unless an emergency arises.

Not Public Interest Entities

Firms should provide safeguards to reduce the threat to independence to an acceptable low level

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LOGOSituations of Advocacy Threat


An advocacy threat often arise in the provision of legal or corporate finance services.

Firms must avoid being in the position of taking the entity’s part in a dispute or somehow acting as their advocate (in support) in a way that threatens the appearance of independence.

ie defended the client in a legal case.

Or promote on behalf of the client

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LOGOSituations of Familarity Threat


What is the threat about ?

Too closely connected or too familiar with or sympathetic to the entity and its employees.

Examples :

Long association of senior personnel with entities

Rotation of Key audit partners

Second partner reviews

Internal independent quality control reviews.

Family members

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LOGOSituations of Intimidation Threat


What is the threat about ?

Arises when members of the assurance team are intimidated or pressured to act unethically by entity staff.

Examples :

Loss of fees - under pressure the entity may apply pressure to reduce the extent of work

Loss of business - as a result of a disagreement over the application of an accounting principle

Replacement with another auditor and litigation

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LOGOTechniques on Ethics


• There would be multiple threats of independence.

• Students should count marks as students often write too much for questions in ethics.

• Consider the significance of each threat and consider whether it is related to a public listed entity.

• No need to give all safeguards but to give the most important.

• Students may consider to answer the question on ethics if it is examined in Section B

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LOGOGoing Concern


•Going Concern

•LP Chapter 16 – Point 2

•Examined in Section A and B

•Examined in conjunction with audit reporting

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LOGOGoing Concern


Going Concern [HKSA 570]

HKAS 1

For the business for the foreseeable future with neither the intention to liquidate or cease trading or has no realistic alternative. continue on going concern basis

Management’s responsibility

•It is management's responsibility to make assessment on whether the entity can continue as a going concern, not the auditor's responsibility.

• When management is aware of material uncertainties that may cast significant doubt upon the entity's ability to continue as a going concern, uncertainties should be disclosed.

Y.E 31/3/2012 Y.E 31/3/2013

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Going Concern


Auditor’s responsibility :

• Consider sufficient disclosure• Consider management use of going concern assumption appropriate

or not• Consider events and conditions that cast significant doubt on going

concern• Discuss with management its plans and resolution of any identified

going concern issues.

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LOGOGoing concern indicatorsFinancial Net liability or net current liability position Fixed-term borrowings approaching maturity without realistic

prospects of renewal or repayment Excessive reliance on short-term borrowings to finance long-term

assets Withdrawal of financial support by creditors, holding entity and

shareholders Negative operating cash flows Inability to pay creditors on due dates Inability to comply with terms of loan agreementsOperating Management intentions to liquidate or cease operations Loss of key management without replacement Loss of a major market, key customers, licence, or principal suppliers

Going Concern


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LOGOIf events or conditions identified :Confirming the existence of the material uncertaintyEvaluating management's plans for future actionsEvaluating the reliability of underlying data used to prepare a cash flow forecast and considering the assumptions used to make the forecastConsidering whether any additional facts or information have become available since the date management made its assessment such as interim financial statements, board minutes, correspondence with lawyersReviewing subsequent events affecting going concernAnalysing and discussing cash flow, profit and other relevant forecasts with management

Going Concern


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LOGOAudit Reporting

Report HKSA 705 (Clarified) a material uncertainty exists and there is inadequate disclosure in the financial statements, the auditor shall express a qualified opinion or adverse opinion

If the financial statements have been prepared on a going concern basis, but in the auditor's judgment this is inappropriate, the auditor must express an adverse opinion.

If management is unwilling to do so, a qualified opinion or a disclaimer of opinion in the auditor's report may be appropriate, because it may not be possible for the auditor to obtain sufficient appropriate audit evidence regarding the use of the going concern assumption in the preparation of the financial statements.

Going Concern


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Past Papers Review


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Past Paper Exam ReviewRisk Assessment - QP Module C – Dec 2011 – Qu 7

Question You are the auditor of CC Limited (CC). CC acquired DD Limited during the year and recorded goodwill of HK$300 million and intangible assets such as trade mark, patent and customers relationship of HK$500 million. Management of CC engaged X Limited to value the intangible assets and advise on the business valuation of the transaction. Based on the business valuation performed by X Limited, CC developed its goodwill impairment assessment and concluded that no goodwill impairment is necessary.

Required: (a)Evaluate and explain the risk of material misstatement relating to the valuation assertion of CC Limited’s goodwill and intangible assets as at 31 December 2011.

(4 marks)


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Past Paper Exam ReviewRisk Assessment : QP Module C – Dec 2011 – Qu 7

AnswerThe valuation of goodwill and intangible assets may be materially misstated if:[Consider which assertion is most important]FV – Impairment Loss - Consider amortisation

Improper business and intangible asset valuation prepared by X Limited due to wrong assumptions, business data and valuation methodology used;

Certain intangible assets are not identified from the acquisition;

Useful life of the intangible assets are over-estimated; and

Goodwill impairment assessment was not properly prepared by management with reference to inappropriate business data and assumptions.


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Past Paper Exam ReviewEthics QP Module C – May 2009 – Qu 5

DEF is a company incorporated in Hong Kong. It is listed on the Hong Kong Stock Exchange. The principal activities of the company are property investment, management and development. Mr. Chan, DEF’s Chief Executive Officer (“CEO”), Chairman of the Board and major shareholder, has asked Simon, FCPA and DEF’s financial controller, to falsify certain documents and accounting records of DEF so that Mr. Chan can misappropriate $1 billion of DEF’s cash for his personal investments. Mr. Chan promises to pay back the $1 billion to DEF in a month and indicates that he will give Simon a very favourable assessment for Simon’s bonus and promotion evaluation for the current year; otherwise, he will replace Simon by someone who will work better with him.

Required: Based on the information given above: (a)comment on the ethical issues; and (5 marks)(b) outline the possible actions Simon would need to take to address these ethical issues. (5 marks)

(10 marks) www.etctraining.com.hk

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Past Paper Exam ReviewQP Module C – May 2009 – Qu 5Answer : (a)

Since Simon is a salaried employee of DEF, Simon is a professional accountant in business and is required to comply with the Code. A professional accountant in business should prepare or present financial and other information fairly, honestly and in accordance with relevant professional standards.

Financial and non-financial information should be maintained in a manner that describes clearly the true nature of business transactions, assets or liabilities and classifies and records entries in a timely and proper manner.

Self-interest or intimidation threats may occur where a professional accountant in business may be pressured (either externally or by the possibility of personal gain) to become associated with misleading information or to become associated with misleading information through the actions of others.


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Past Paper Exam ReviewQP Module C – May 2009 – Qu 5

Answer : (a)

In this case, Chan’s request for Simon to falsify certain documents and accounting records of DEF in return for a favourable assessment for Simon’s bonus and promotion evaluation for the current year represents a self-interest threat.

Also, Chan’s threat to replace Simon if Simon does not accede to the request represents an intimidation threat.


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Answer : (b)

Actions to be taken

Since Chan is the CEO and major shareholder of DEF, it is inappropriate to report the fraud or suspected fraud to other senior management who are actually Chan’s subordinates.

As Chan is also the Chairman of the board of directors, reporting the matter to the Chairman of the board of directors might not be desirable for Simon either.

DEF is a listed company and all listed companies in Hong Kong are required to establish an audit committee, of which the Chairman should be an independent non-executive director. Simon should thus report the matter to the Chairman of the audit committee.


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Answer : (b)

As a last resort, Simon may consider making a report to an appropriate external authority such as the police or the ICAC in line with the ethical guidance on the duty of confidentiality.

When in doubt, Simon is recommended to seek legal advice.

Simon should be aware that he himself commits a criminal offence if he helps Chan in the planning or execution of Chan’s plan to misappropriate DEF’s $1 billion cash.

Simon should also be aware that he may incur civil liability to third parties if he is involved in Chan’s unlawful conduct by assisting Chan in the planning or execution of the unlawful conduct.


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Past Paper Exam ReviewEthics : QP Module C – June 2011 – Qu 7

Question :

You established your own CPA practice six years ago which has now grown into a 15-staff firm. Your firm has been the auditor of an unlisted company, PQR Investment Limited (“PQR”), for six years. The shareholders of PQR have recently injected HK$90 million of new capital into PQR with a view to acquiring companies in India, Thailand and Japan. Required: Discuss what your CPA firm should consider before continuing to serve as the auditor of PQR in the forthcoming year. In particular, your discussion should be put in the context of PQR’s circumstances.

(13 marks)


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Past Paper Exam ReviewEthics : QP Module C – June 2011 – Qu 7

Answer :HKSQC 1 (Clarified) – Client Acceptance ProceduresThose matters include: - the integrity of PQR (i.e. its shareholders, directors and management); - whether your firm is competent to do the work; and - whether your firm meets ethical requirements in relation to the work.

No clear evidence compromising the integrity of PQR [Management integrity]As your firm has been the auditor of PQR for six years, competency is not likely to be questioned.

However, the increase of PQR’s scale of activities and its forthcoming overseas acquisitions may challenge your firm’s competency.


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Exam Preparation I

Risk Assessment : QP Module C – June 2011 – Qu 7

Answer :

Challenges may include the industries, locations and sizes of those companies being acquired as well as the forms of investments (e.g. equity, debt or quasi-equity) and the availability of properly audited financial statements.

Being associated with PQR (as its auditor) for six years may indicate a close relationship. However, it is not entirely clear if the extent of relationship may pose any familiarity threat to your firm.

You should be satisfied that appropriate procedures regarding the continuance of client relationship and audit engagement with PQR have been followed, and that conclusions reached in this regard are appropriate and have been documented.


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Exam Preparation I

Going Concern : ETC Question

Medi Co is an established pharmaceutical company that has for many years generated 90% of its revenue through the sale of two specific cold and flu remedies. Medi has lately seen a real growth in the level of competition that it faces in its market and demand for its products has significantly declined. To make matters worse, in the past the company has not invested sufficiently in new product development and so has been trying to remedy this by recruiting suitably trained scientific staff, but this has proved more difficult than anticipated.

In addition to recruiting staff the company also needed to invest $2m in plant and machinery. The company wanted to borrow this sum but was unable to agree suitable terms with the bank; therefore it used its overdraft facility, which carried a higher interest rate. Consequently, some of Medi’s suppliers have been paid much later than usual and hence some of them have withdrawn credit terms meaning the company must pay cash on delivery. As a result of the above the company’s overdraft balance has grown substantially.


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Exam Preparation I

Going Concern : ETC Question (Cont’d)

The directors have produced a cash flow forecast and this shows a significantly worsening position over the coming 12 months.

The directors have informed you that the bank overdraft facility is due for renewal next month, but they are confident that it will be renewed. They also strongly believe that the new products which are being developed will be ready to market soon and hence trading levels will improve and therefore that the company is a going concern. Therefore they do not intend to make any disclosures in the accounts regarding going concern.

Required : Explain the audit procedures that the auditor of Medi should perform in assessing whether or not the company is a going concern.

(7 marks)


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Exam Preparation IGoing Concern : ETC Question (Cont’d)Answer :Obtain the company’s cash flow forecast and review the cash in and out flows. Assess the assumptions for reasonableness and discuss the findings with management to understand if the company will have sufficient cash flows.

Perform a sensitivity analysis on the cash flows to understand the margin of safety the company has in terms of its net cash in/out flow.

Review any current agreements with the bank to determine whether any key ratios have been breached.

Review any bank correspondence to assess the likelihood of the bank renewing the overdraft facility.

Discuss with the directors whether they have contacted any alternative banks for finance to assess whether they have any other means of repaying the bank overdraft.


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Exam Preparation I

Going Concern : ETC Question (Cont’d)Answer :Review the company’s post year end sales and order book to assess if the levels of trade are likely to increase and if the revenue figures in the cash flow forecast are reasonable.

Review post year end correspondence with suppliers to identify if any further restrictions in credit have arisen, and if so ensure that the cash flow forecast reflects an immediate payment for trade payables.

Inquire of the lawyers of Medi as to the existence of litigation and claims, if any exist then consider their materiality and impact on the going concern basis.

Perform audit tests in relation to subsequent events to identify any items that might indicate or mitigate the risk of going concern not being appropriate.

Review the post year end board minutes to identify any other issues that might indicate financial difficulties for the company.


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Exam Preparation I

Major topics :

Corporate Governance (8-10 marks)Ethics (8-10 marks)IT (8-10 marks)Audit (over 50 marks – risk assessment (15 marks)

Be aware of new standards :

HKSA 265 (Clarified), HKSA 450 (Clarified), HKSA 600 (Clarified), HKSA 705 (Clarified), HKSA 706 (Clarified), HKSA 800 (Clarified), HKSA 805 (Clarified)


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Exam Preparation II

Be aware of New Terms :

Clearly trivial Pre-conditions Significant deficiencies Exceptions Group engagement partner / Component auditor Other matter paragraph Written representations Management bias Management and auditor’s experts Point estimate


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aim to encourage you.Thank you!!!

Email: [email protected] Website: www.etctraining.com.hkwww. etctraining.com.hk

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