Jimmy Farnham is the external auditor for Aussie Outback Tours Ltd, a company which promotes tours to the Australian outback and owns a chain of souvenir shops. Jimmy has been auditing the company since it was listed on the Australian Securities Exchange 7 years ago. Although the financial statements of the company have never received a qualified audit report, Jimmy is aware that the company has been making losses for the past 2 years as a result of short-term cash flow difficulties influenced by the global financial crisis. The company has no long-term loans and the bank overdraft is near its limit at the end of the current financial year. During the current financial year, the company upgraded its accounting system to a computer database. An IT consultant was contracted to assist in the correct changeover of files for this system. At year-end, this new system had been in place for 6 months, and the directors have advised Jimmy they are happy with the way it is operating. Jimmy does not have the expertise to review and evaluate the database management system, so he asks an independent expert to undertake this role. This person concludes that the system appears reliable and that the changeover was correctly carried out. Jimmy has never before audited this type of system, so he attends some courses to familiarise himself with its features. His accounting firm has a standard work program that he uses to test the internal controls operating within the new system. In Jimmy’s review of the minutes of the board of directors’ meetings, he becomes aware that the company’s major shareholder (which currently owns 35 per cent of the shares of the company) is considering making an offer to purchase the remaining shares. This is because the company’s share price is trading well below its net asset backing. After the company’s audited financial statements for the current year are published, the takeover offer from the company’s major shareholder proceeds on the basis of an offer price equivalent to the net asset backing of $2.20 per share (as determined from the financial statements). The takeover offer results in acceptances from 94 per cent of the company’s other shareholders and compulsory acquisition proceedings have been instituted for the other 6 per cent. 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 the year-end inventory at the souvenir stores being materially overstated. After the subsequent write-down of inventory, the correct net asset backing of $1.40 per share is calculated. The major shareholder commences legal action against Jimmy for alleged negligence for its loss of $0.80 per share. Required: Explain whether you believe the major shareholder would be successful in the legal action for negligence against Jimmy Farnham. In doing so, you should discuss and apply each of the four criteria/tests listed on p. 209 of the Leung et al textbook, as well as potential defences that could be used by Jimmy including contributory negligence. 3 Question 2: (Approximately 350 words) Alfies Ltd is a public company that competes in the highly competitive market for manufactured household products. The company is dominated by Peter Slapper, the chairman and chief executive officer, who has guided the company since it was a private company and has extensive influence on all aspects of company operations. Peter is known to have a short temper and in the past has threatened individuals in the accounting department with no pay rise if they failed to help him achieve company goals. Furthermore, the company has extended its influence over customers and has dictated terms of sale to ensure that customers are able to obtain desired quantities of their most popular products. Bonuses based on sales are a significant component of the compensation package for individual product sales managers. Sales managers who do not meet sales targets three quarters in a row are often replaced. The company has performed well up until a recent recession, but now the company is having difficulty moving inventory in most product lines as retailers have difficulty selling in a down economy. Required: (a) Identify five (5) fraud risk factors that are present in the above case, as well as explaining why they represent a risk; (b) Identify two (2) account balances and assertions that are most likely at risk of misstatement based on the fraud risk factors in the case. Also, briefly explain why the balances and assertions are at risk. Question 3: (Approximately 350 words) You are a senior auditor working on the audit of BodScan Ltd for the year ended 30 June 2015 and are in the planning stage of the audit. It is April 2015 and you discover that BodScan has recently acquired two new, full-body scanning machines, representing the very latest in technology, at a cost of more than $20 million each. The machine enables a full 360 degree scan of the body with the ability to identify tumours, cysts and other abnormal internal growths which currently have only a 40% probability of being detected with other scanning devices on the market. Recent studies have shown there may be potential long-term side effects to patients who are scanned by the new technologically advanced machine. However, given the machine has only just arrived on the market, the results will not be known for many more years. This uncertainty and the potential high risk associated with the machine have caused bad press for both the scanning machine and BodScan. BodScan charges patients a premium price for body scans performed by the scanning machine due to its advanced technological abilities. As a result of high demand, hospitals using the machine have decided to reserve its use only by patients who pre-pay for their scan, i.e. all scans must be paid for in full by patients at the time of booking. Payments are then immediately recognised as revenue by the hospital. Demand for the scanners has been extremely high and BodScan now has bookings for four months in advance. You note that even though it is only April 2015, the hospital already has bookings for July and August 2015. The Medical Association of Queensland is currently reviewing the use of the scanning machines and is considering banning their use within Australia until the issue is resolved. The decision is expected to be announced by the Association on 1 August 4 2015. The management of Bodscan believe there is a 20% chance that the scanners will be banned. Required (a) Identify and briefly explain two (2) business risks that are evident in the above case; (b) Identify two (2) account balances likely to be at risk of overstatement as a result of the business risks. For each account balance, identify and explain the key assertion most at risk. Question 4: (Approximately 400 words) You are about to complete the planning stage of the audit of Fast Print Ltd and you are considering your audit approach to the following events that have occurred during the year. Fast Print Ltd’s revenue for the current financial year is $50 million and profits are $6 million: (a) A customer has made a claim against Fast Print Ltd for breach of contract. It claims that products were not delivered in accordance with the contract and this led to them having to engage other contractors to carry out the work at great expense. The customer is suing the company for damages of $2 million. (b) A major customer has not paid Fast Print Ltd for three months and the receivable balance at the year-end for this customer is $240,000. The customer is rumoured to be having significant cash flow difficulties; however, Fast Print Ltd’s directors believe the customer will pay the amount owing as it is a long standing customer that has always paid in the past. (c) Fast Print Ltd recently purchased new machinery for its factory. This replaced old machinery, which is no longer being used but is still included in the balance sheet at a carrying amount of $4,500,000. The old machinery has not reached the end of its originally expected useful life and remains on the balance sheet and is being depreciated in line with previous years. Required: Describe the substantive procedures that would provide sufficient appropriate evidence in relation to each of the three issues outlined above.