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SOLUTION MANUAL
to accompany

MODERN AUDITING
&
ASSURANCE SERVICES
5th edition
Prepared by
Philomena Leung, Paul Coram, Barry Cooper and
Peter Richardson

© John Wiley & Sons Australia, Ltd 2011

Solution Manual to accompany Modern Auditing and Assurance Services 5e

Chapter 3 Professional ethics, independence and audit
quality
Review questions
3
...
The study and practice of ethics are
important to enable accountants to examine critically a situation in which there is a
conflict of loyalties and interests, involving issues that relate to roles and
responsibilities, both as an individual and a professional
...
Ethics therefore not only encompasses professionalism and the code of
professional conduct which accountants should adhere to, it relates to the numerous
decisions accountants make, as a professionally responsible accountant, safeguarding
the public interest, and the underpinning system which helps the accountant to
manage difficult situations
...
They include
standards of behaviour for professional accountants and are incorporated into the
Code of Ethics for Professional Accountants (APES110) issued by the Accounting
Professional Ethics Standards Board established by the CPA Australia and The
Institute of Chartered Accountants in Australia
...

Auditors are also expected to comply with various requirements of common law
where the duty of care and diligence is applied to their professional services
...
12

What are the ethical threats to professional independence? What are the
safeguards for managing such threats?
Threats

Self-interest threats

Self-review threats

Safeguards
Prohibition of providing non-audit
services, fees based on reasonable
estimates of time and expertise required,
stringent independence guidelines and
monitoring
by
firms,
legislative
restrictions on auditors regarding
independence
...

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Prohibition of business relationships,
strict rules on referencing clients, rotation
of audit partners
...

Engagement review, fee structures,
procedures regarding resignation and
removal of auditors, audit committee
structure
...


3
...

Personal and business relationships
Relationships such as these may jeopardise the independence of auditors in such a
way that his/her judgement is compromised
...


© John Wiley & Sons Australia, Ltd

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Management pressure
Inability to withstand management manipulation may lead to the failure of auditors to
form an adequate and independent opinion
...
15

Explain, with examples, how the complexity of the roles of accountants in
terms of their responsibilities and relationships with others would affect
auditors’ performance of their duties
...
This
may result in an ethical dilemma of divided loyalties
...

 Complexity of accounting information for which the auditor fails to fully
appreciate the substance of transactions involved
...

 An increasing amount of non-audit services being rendered, leading to close
relationships between audit partners and the client
...

Ethics may assist in these circumstances in the way to sensitise the auditors
concerned, so that a systematic approach of ethical decision-making process can be
used by the auditors to uphold his/her integrity and to perform their duties with
independence and objectivity
...
16

Are all auditors registered accountants? What are the drawbacks to nonregistered accountants becoming auditors?

Accountants must be registered with the ASIC before they become auditors
...
It is important that auditors must be registered as:


There is no specific legislative protection to the occupation of ‘accounting’,
hence a person can undertake the role of an accountant without being
qualified
...


© John Wiley & Sons Australia, Ltd

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Stakeholders rely on the expertise and objectivity of the
audit opinion
...


3
...
However, as Barbara Toffler observes in her book on “The Rise and
Fall of Arthur Andersen” the collapse of Enron was just “the final nail in the coffin of
Arthur Andersen” Andersen had a number of audit failures (eg
...
Andersen, competing against its offshoot
Andersen Consulting (that was to become Accenture), had developed a culture that
was all about making money, rather than maintaining its independence and
conducting high quality audits
...


3
...

Regulation enhances the status of the audit profession and provides a framework
whereby the profession and its firms use it as bases of operation
...

3
...
Quality audits are essential to ensure that the
profession meets its responsibilities to clients, to t he general public and to regulators
who rely on independent auditors to maintain the credibility of financial information
...
This framework encompasses many of the activities
of the private and public sector organisations associated with the profession
(described earlier in this chapter)
...
The professional bodies and IFAC issue ethical codes to
establish and monitor the performance of professionalism and ethical behaviour of
professional accountants
...

© John Wiley & Sons Australia, Ltd

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• Government regulation: The FRC, ASIC and CALDB, along with the courts,
monitor and regulate auditor independence and conduct
...
20

Why is the audit profession losing its self-regulation rights?

The audit profession has been seen to be involved with audit failures, leading to major
corporate collapses
...
Self-regulation rights that remain
with the profession only include examination, initial disciplinary hearings, the
establishment of the Accounting Professional and Ethics Board and the command for
CPD
...


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21 Professionalism
Required
Explain to Frank the importance of professionalism, using the Code of Ethics for
Professional Accountants and particularly referring to its guidance on
competence
...
It is acknowledged that non-professionals to a lesser degree also
possess these attributes
...
Professionals
would also claim that they benefit society by their superior performance in fulfilling a
highly competent and sophisticated role
...
The profession would see this
regulatory code as a key way of differentiating itself from other organisations
...
Self-regulatory codes are characteristic of all occupations
...
The code also provides the principles
of competence and due care, and guidelines where accountants and auditors should
avoid performing tasks, which they are not competent in
...
Where there are doubts relating to the tasks, he should raise it with his
seniors and seek independent advice if necessary
...
Section 130 of the Code of Ethics for
Professional Accountants (APES110) refers to the requirement to maintain adequate
professional knowledge and technical skills regarding professional competence
...


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Ethical decision-making

Required
Analyse the ethical issues you confronted
...

There are two possible ethical issues here
...
Secondly, it appears that the audit partner is too close to Craig and given,
the time pressures to complete the audit, he may compromise his independence and
objectivity
...


© John Wiley & Sons Australia, Ltd

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23 Ethical issues
Required
For each of the previous four situations, (a) identify the ethical issues involved,
and (b) discuss whether there has been any violation of ethical conduct
...

1
...

(b)
The guidelines in APES 110 permit the provision of write-up services
to proprietary company audit clients and, in exceptional circumstances only,
which may be the case here, to public company audit clients
...
A fundamental ethical requirement
is that, if Lola is to be assigned to the job, she must be competent to provide
the required service
...


2
...
It is however required that an auditor should
inform the authorities should there be a breach of the law
...
The appropriate course of action would have
been for Lola to draw the matter to the attention of the partners in her firm,
who should attempt to persuade management to take corrective action
...
As a last resort
the firm should consider the desirability of continued association with a client
in the light of doubts as to the integrity of management
...


(a)
The ethical issue here is that of whether the acceptance of a gift
prejudices the appearance of independence
...

(b)
The gift should be considered whether, in the opinion of a well
informed third party, that the gift was clearly insignificant
...
It appears that the client did not indicate an intent to influence
decisions
...
However, acceptance of the gift by Lola could give the
impression that she had not been impartial in performing her duties or that, in
future, her objectivity would be impaired
...


© John Wiley & Sons Australia, Ltd

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(a)
The ethical issue here relates to the duty of care that accountants have
with respect to handling clients’ trust funds
...

(b)
The partner’s behaviour in this situation appears to be unethical
...


3
...

Steven has breached the Code of Ethics on confidentiality
...

The fact that Steven is not yet a member of the ICAA or CPA Australia does not
preclude him from complying with the Code as it is stipulated that the Code is
applicable to both student members and full members
...
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Chapter 3: Professional ethics, independence and audit quality

3
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(b) Indicate in each of the above circumstances whether the effect on
professional ethics is (i) a violation; (ii) not a violation or (iii)
indeterminate, and explain
...
14a Integrity – should be straightforward and honest in all professional and
business relationships
1
...

1
...

1
...

1
...


1

Effect
Violation

Rule
1
...
14d

4

Violation

-

5
6

Not a violation
Not a violation

-

7

Not a violation

-

8

Not a violation

-

9

Not a violation

-

Reason
An accountant should only undertake work that
he or she can expect to complete with
professional competence
...
Advertising should be
on the services provided
...

If client’s consent is obtained, it can be part of
the professional clearance procedures
...
Solicitation
of client should not normally be allowed
...

Reasonable courtesy or social commitments can
be allowed
...

Commission should be disclosed
...

Normal course of event allowed
...

(Note: The Corporations Act has a limit of $5
000 on non-housing loans)
An accountant has a legal right of lien, under
certain conditions, over clients’ records in his
custody in the event of non-payment of fees
...
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Solution Manual to accompany Modern Auditing and Assurance Services 5e

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Ross’s acceptance of the dual roles of company secretary and
auditor
...
However, the dual role of the public accountant will certainly cause
reasonable users of the audited accounts to doubt whether the auditor was genuinely
able to view, independently, questionable transactions undertaken by the company
during the period of his secretaryship
...


3
...
Support your views with the current
guidelines and recommendations for professional independence
...
APES 110 on independence, includes the following as one of its
principles: ‘A member in public practice must be, and be seen to be, free of any
interest which is incompatible with objectivity
...
If an
auditor is not thought to be independent, no matter how objective that person feels
himself or herself to be, the perceived lack of credibility will render the audit report
valueless
...

1
...
Moreover, as he recruited the current CEO,
there is also the risk of advocacy
...


The offer of the shares at a discount of 20% on market price is not only
significant, it also creates the existence of self-interest in the business by the
firm
...
The audit partners should consider taking
action to recover the fees before any further audit engagement commences
...


Kevin should not agree to join the board, despite his relationship and
knowledge of the business
...


© John Wiley & Sons Australia, Ltd

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Incompatible duties

Required
(a) Nominate which of these services Brian may perform
...
What are these matters?
(a) Brian may perform
 Counsel on potential expansion plans
 Search for and interview new personnel
 Train personnel
The following are matters that Brian should not perform
...

Brian should be qualified to supervise and evaluate the work of specialist employees
...
All work should be subject to clear engagement and that Brian should not be
involved in management decision-making, but only as an advisor
...
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Solution Manual to accompany Modern Auditing and Assurance Services 5e

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(b) Do you think it is adequate just to ask for more time? Why or why not?
(c) If your manager told you to simply follow a standard audit program for the
audit, what would you do? Explain in full what your actions would be and
why
...
Audit quality control procedures, along with professional
standards and legislative requirements, are crucial elements to underpin the
competence to be demonstrated by auditors
...
However, as you may not have
the required specialised knowledge, there should be provision for more supervision
and perhaps on the job training from an audit manager
...

The auditor should discuss fully with the audit partners or manager the situation and
request more information to be provided, if necessary
...

(c) If the manager requires you only to follow a standard audit program, you should
discuss the matter in more detail with the manager, explaining that the standard audit
program may be insufficient for the purpose
...
You should also seek
for suggestions to improve the audit by obtaining more information and devising your
special audit tasks to be performed, and then discuss them with the manager
concerned
...
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Chapter 3: Professional ethics, independence and audit quality

Case studies
3
...

(b) Recommend a course of action for Noreen
...


(b) The issue of the non-signing of the contract by Dumpound should be raised with
management, as it may have audit implications
...

If there is certainty that the client is effectively conspiring with Dumpound to illegally
dump toxic waste, it should in the first instance be raised with management
...
311)
...

in the public interest
...
It arises where the
illegal act, or intended illegal act, could result in great social harm
...


© John Wiley & Sons Australia, Ltd

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31

Ethical issues in auditing

Required
Discuss the professional and ethical issues faced by John and provide an analysis,
which can help him deal with the matter with Chandler
...
may mean
that John’s conclusion may be based on incomplete information
...

 There is the argument that Chandler is being negligent in concealing the true
situation about internal control, leading to a misleading impression given on
the affairs of the company, which is to be listed
...

Ethical issues:
 John’s loyalty to his supervisor Chandler v
...
his disguise
...
his desire to maintain the client’s business
...
To proceed with the truthful report, or to
follow Chandler’s action and remain silent, to inform the ASX, or to raise it
with another review partner
...


© John Wiley & Sons Australia, Ltd

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Audit Independence

This is a guide for students only
...

Why is audit independence important and what do you think is the role of
the FRC in this regard?
Independence is the cornerstone of the auditing profession
...
An auditor may be pressured
by management to compromise his or her objectivity in deciding on an accounting
policy, for example, or an accountant may be instructed by a superior to amend
financial statements so as to show a profitable return
...

Without independence, the auditor’s opinion is suspect
...
Directors’ remuneration, the value of the shares they hold and even their
position within the company may all depend on the financial performance of the
company
...

Recognising this connection, directors may seek to influence the auditor
...

The fact of auditor independence is not always readily visible to those relying on the
auditor’s opinion; situations in which a reasonable person might consider the auditor’s
independence to be impaired have been criticised in the past
...
Independence in mind can be assessed using a
‘reasonable person’ test, whereas independence in appearance is based on specific
rules or prohibitions
...
In particular it
performs reviews and investigation of audit independence and audit inspection
programs in order to report to the government concerning the state of audit
independence
...
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Solution Manual to accompany Modern Auditing and Assurance Services 5e

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The issues include:







Clarification of the circumstances and the guidelines for managing conflicts of
interest situations
...

The relationship regarding trust accounts, referrals and other non-audit related
services; and how these services can be performed and managed without
compromising audit independence
...

Reduction of competition amongst audit firms
How the audit profession can manage skills shortage which impacted upon the
recruitment of audit personnel by other firms and by clients
Training resources necessary for mid-tier firms and specialisation amongst
audit firms
...


Enhancing professional standards and disciplinary procedures;
Supporting audit firms in relation to quality controls and training;
Providing more rigorous audit inspection support for ASIC;
Enhancing specialisation within the audit profession
...


The first inspection results have been provided to the FRC as set out under a
memorandum of understanding between the two organisations
...
ii On 23
October 2006, the FRC submitted the 2005/6 Auditor Independence Report to the
Treasurer
...
Subsection 235BA(1) of the ASIC Act requires the
FRC, by 31 October each year, to prepare a report on its performance of auditor
independence functions, the findings and conclusions and the actions undertaken by
the FRC in respect of those findings
...
The
overall conclusion that the FRC has reached is that auditor independence framework
© John Wiley & Sons Australia, Ltd

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No systematic issues were discovered
...
Although a small number of instances where
individuals were found to have failed to comply with the independence requirements
of the Corporations Act 2001, the firms concerned asserted that these were addressed
promptly
...
The consultants have also noted the absence of a
requirement for auditors in Australia to belong to a professional accounting body as a
pre-requisite for registration as a company auditor, and for the continuation of that
registration
...
In respect of the
examination of disciplinary procedures, the FRC concluded that the procedures of
each body were adequate
...
ASIC reports on the first year of its auditor inspection
program, www
...
gov
...

ii
Auditor independence inspection program, September 2005, Australian Securities and Investments
Commission
...
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