Audit Risk Analysis and Liability for Anthony's Building Company Ltd

Overview of Anthony's Building Company Ltd.

Answer AT LEAST TWO questions, and NO MORE THAN THREE questions from this section. You are the audit partner for Anthony’s Building Company Ltd. (ABC), a property developer specialising mainly in residential housing. At the end of 2019, the assets of the company were valued at cost at £250m. Sales totalled £100m for the year with ABC 10% net profit. Seeking to diversify, in the first two months of 2020, ABC borrowed extensively to finance the acquisition of several out-dated high street stores for re-development. The additional borrowing took the company close to the gearing limits imposed by the bank. In March 2020, the UK entered a two-month lockdown because of the Covid pandemic. Sales of houses collapsed and high street stores were forced to close. Subsequently, UK restrictions have been relaxed and then re-imposed.  With an increased demand for outdoor space, house prices rose but business in high street stores remained low with one industry expert predicting that the British high street will never be the same. In August 2020, ABC featured in a consumer programme on a local TV network in which ABC customers complained about the build quality of ABC housing.  The largest estate still being developed was highlighted for defects in workmanship including one house which was so badly built that it had to be demolished and rebuilt.  ABC paid for this and for rehousing the occupants in the meantime. ABC’s insurer refused to cover these costs saying that such extreme carelessness was not covered by its policy. The site manager attempted to calm other complainants by offering cash rebates of up to 10% of the purchase price if the complaint was dropped. Potential interest in all ABC’s houses decreased after the programme aired. On another development site, initial construction work was stopped when the remains of a rare type of Roman villa were uncovered. Early investigations suggest that the historic remains cover 90% of the site and that archaeological investigations will take at least two years to complete. ABC’s directors are convinced that ABC is a going concern and assure you that exciting alternative uses will be found for the town centre properties recently acquired though they are unable to provide you with any definite plans. Required: a) By undertaking a risk analysis, identify and explain your main concerns regarding the audit of ABC? (15 marks) b) To what extent can auditors be held liable if a company were to collapse shortly after receiving an unmodified opinion? (10 marks)  ReCharge Ltd is a UK company specialising in the manufacture of batteries for electric vehicles (EV batteries). The company is new to the market and was started by two engineers with experience in the development and production of EV batteries. The EV battery market is challenging for new companies due to the dominance of large corporations with big budgets for research and development. ReCharge Ltd’s niche is that it is a fresh face to the market with a strong focus on being environmentally-friendly in its production processes and in its desire to promote green motoring. Whilst it is expected that the market for EV batteries will continue to grow as the demand for EVs increases, market research has shown that customers are reluctant to purchase an EV. Potential customers’ top three concerns are the range between battery re-charge, the cost of EVs and the small number of charging stations in the UK. The directors of ReCharge are keen to address these issues and this year they have already invested large sums of money in research and development projects to produce smaller, lower cost batteries with a greater range. Whilst increasing range should reduce concerns about the lack of charging stations the directors are in talks with a larger competitor about the feasibility of working together to build more charging stations. ReCharge Ltd is based in the South of England and in recent months two cities in close proximity to ReCharge Ltd’s headquarters have announced plans to ban diesel and petrol cars from their city centres within the next 5 years. Funds have so far come from a loan from a local bank and capital invested by the existing directors/shareholders. However, given the scale of the project to develop lower cost, higher range batteries, ReCharge is now looking for alternative sources of investment. They have approached funding bodies in the UK and Europe with their plans. In order to support these applications they require audited accounts. The directors consider this funding to be essential to their future plans due to the increasing threat of overseas companies entering the market. Required: Detail at least six potential audit risks associated with the audit of ReCharge Ltd. Having detailed the risks, make an assessment of whether your audit firm should accept or reject this audit appointment. Give an explanation of your decision. In accordance with the International Standards on Auditing, auditors take a risk-based approach to their audit work. What do you understand by the term ‘risk-based’ and what are the potential disadvantages of such an approach? You are the technical partner of a medium-sized firm of auditors. Your senior partner has become concerned about the increased exposure to legal liability in the event that the firm issues an inappropriate audit opinion. You have been instructed to examine a random sample of audit files and to review the appropriateness of the opinion signed in each case by different audit partners. Your selection included the following cases: Client Alpha: certain disclosures required by the Companies Act in relation to the directors’ remuneration had been omitted. The audit partner considered that the total amount involved was not material and signed an unmodified opinion. Client Bravo: inventory records relating to one of its depots could not be found.  The depot accounted for 1% of Bravo’s sales and 0.5% of the total profit. The audit partner had modified the opinion on the financial statements using the ‘except for’ style and had modified the opinion on the keeping of proper books and records. Client Charlie: minor errors had come to light at the very end of the audit. The effect of the errors was to understate non-current assets by 0.5% or 5% of the materiality threshold. The audit partner had signed an unmodified report. Client Delta: Delta is in the middle of a lawsuit brought against it by one if its major customers demanding that extensive repairs be carried out to faulty equipment supplied by Delta. Delta’s directors made no mention of the case in their report or in the notes to the financial statements. The audit partner signed an unmodified report, after having seen correspondence from Delta’s lawyers to the effect that the customer’s case against Delta is weak. Client Echo: faced with a liquidity crisis before its year-end, Echo’s directors were looking for sources of new finance. Their search had not proved successful by the time the accounts had to be signed off. The directors prepared the financial statements on a going concern basis but made a full and frank disclosure of the position and the effect if no further finance could be found. Nevertheless, the audit partner modified the opinion on the grounds of disagreement with the going concern assumption. Required: a) Assess the appropriateness of each of the audit opinions stating your reasons for agreeing or disagreeing with the style of opinion given.  b) Write a brief training memo for the firm’s new trainees explaining to them what ‘a true and fair view’ means and what an audit partner must consider before signing an unmodified opinion on financial statements.  WBB is a charity which operates a motorcycle courier service for hospitals.  Starting with just one city in 2011, it now covers the whole country. The charity has 500 volunteer members who either ride the motorcycles, raise funds or act as ‘controllers’ directing the riders to locations for pick-up and delivery. The main source of income is voluntary donations; the current year is the first time that income is high enough to require an audit. The charity is managed by a committee of ten trustees, not all of whom take their duties seriously, for example, two of them missed a training session explaining the legal duties and liabilities of being a trustee. In preparation for a bid for the audit work of WBB, you make initial investigations and find the following: For operational purposes the country is divided into 8 areas. Each area has a regional manager and its own small fleet of motorcycles. Each regional manager is issued with a laptop, an electronic pad and a card reader so that donations can be made by bank card. Sometimes one or more of these items goes missing. Often the missing equipment is found but only after the charity has paid for a replacement. You have not been able to ascertain how many of the items the charity currently has. Collection boxes have been left in shops and restaurants to enable customers to make cash donations. The area manager will occasionally visit these locations, empty the boxes and bank the money when convenient. Again, no one can say how many boxes exist. It was suggested that the charity should have T-shirts printed with the charity’s logo. Sale proceeds of the T-shirts would add another income stream. The committee delegated merchandising to a single member five years ago and took no further interest in the matter. Over the years, new lines of merchandise were added but sales have never matched the member’s predictions. No inventory count has ever been conducted. The treasurer has sole control of the bank account. She produces a monthly spreadsheet to show the committee the transactions going through the bank account. The committee authorises large purchases such as new motorcycles.  All other payments are made on the authority of the treasurer who pays the bills on receipt of an invoice from a supplier. The motorcycles have a number of accessories such as a satnav, a 2-way radio or mobile phone. Occasionally, such items go missing and are replaced immediately as they are essential for operations. Under the motor insurance policy, the motorcycles must be kept in a locked garage when not in use. Not all riders comply and there have been cases when a motorcycle has been damaged when left on the street. Since the damage is not covered by insurance, the charity has to pay for repairs. Required: a) Identify and explain your main concerns about the control environment of the charity?b) Make suggestions for improving the operational and financial management of the charity.  

SECTION B Answer ONE question and NO MORE THAN ONE further question from this section. . Identify and explain the similarities and differences between the audit of financial statements and an assurance engagement on a corporate social responsibility report. Critically assess the factors which a court will take into account when deciding whether auditors should be held liable to pay damages to a third party for negligence in the conduct of an audit. Identify the personal qualities which make for an effective auditor of financial statements and illustrate the value of each one with an example of a situation where that quality would enhance the value of the audit. Critically examine the advantages and disadvantages of having concentration in the market for audit services where a small number of audit firms conduct the majority of the audits of large listed companies.