SECTION A:SHORT ANSWER QUESTIONS (Total: 30 marks)Short Question 1James Wong, a CPA with several years experience, has been selected by his firm to be the in-charge auditor of a continuing client. James will supervise three junior auditors, and be responsible for all phases of the audit. The client has a 31 December year end. James intends to do audit planning in September and conduct interim control tests in October.(a) What are the most important uses of the results of the October control tests?(b) What are the issues involved in performing procedures prior to the end of theyear?(3 marks) Short Question 2In auditing the XYZ company cash accounts, you are instructed to obtain bank statements with twelve monthly bank reconciliations, and an independently obtained bank confirmation. Explain the possible uses of both of these types of evidence and indicate whether each constitutes a control test or a substantive procedure.(3 marks) Short Question 3The use of automated processes in accounting systems have both the potential for increasing as well as decreasing the possibility of errors and irregularities. Discuss briefly reasons why computerised accounting may increase the possibility of errors and irregularities, and reasons why computerised accounting may decrease the possibility of errors.(3 marks) Short Question 4The PQR Company hired a new accounting controller to replace the former controller who retired in August. The new controller has experience in the industry, but is not yet familiar with the PQR Company procedures. As the long-time auditor for PQR, you evaluate internal control during October and November.(a) How will having a new controller change your perception of control risk?(b) What actions will you as the auditor need to take as a result of this change in akey client employee?(3 marks) Short Question 5In your audit of the XYZ Company Ltd., you substantively tested the accounts receivable balance by sending out positive confirmations for approximately 30% of the total accounts receivable balance. Upon their return from customers of XYZ, some of the confirmations revealed certain discrepancies.(a) Compare and contrast what the auditor should do if the amount of thediscrepancy is material versus immaterial.(b) What should you do in the following year as a result of the current year'sfindings, and why?(3 marks) Short Question 6Henry is a CPA who has been auditing his client, a publicly traded company, for the past five years. This year the client has experience a change in top management. Henry is not happy with the new desired timing of the audit report and the new fee arrangement, and he wants to resign as the auditor.(a) Explain what Henry must do to resign.(b) Are there any circumstances which he should report when he resigns?(c) Does Henry have an obligation to contact or communicate with the new auditor?(3 marks) Short Question 7The LMN Company has approximately 800 employees, including an accounting department with twenty people, of whom five work solely as internal auditors.Describe the major considerations the external auditor should evaluate before using the work done by the internal auditors.(3 marks) Short Question 8The RST Company Ltd. has been an audit client of your accounting firm for many years, and the firm enjoys a very good relationship with RST. Recently the management of RST has approached your accounting firm for a special one-off consulting engagement. This engagement would be to draw up a new accounting procedures manual and to train the lower-level staff of the RST accounting department. Both RST and the accounting firm intend to continue their relationship as client and auditor outside this prospective consulting engagement.Indicate the concerns that the accounting firm might have about accepting this special engagement.(3 marks) Short Question 9Susan is the manager in-charge of the audit for the Pactrans Company Ltd., which has its headquarters in Hong Kong but also has factories in various parts of Korea. It is customary for Susan's accounting firm to engage local accounting firms to perform certain audit procedures for the factories in Korea. Susan is in charge of planning and evaluating the work of the other auditors.List the issues Susan should consider in her audit planning and her evaluation of the use of audit work carried out by other auditors.(3 marks)Short Question 10Your audit client has operated a very effective manual accounting system since commencement of business many years ago. Recently the company has decided to automate its system in three phases. First it will automate the accounts payable and cash disbursements; shortly afterwards it will proceed with the automation of accounts receivable and cash receipts, and finally it will automate the payroll system. Your accounting firm has been notified that the implementation of automation will take place this year, and the client believes that by the end of the accounting period all three implementations will be completed and in operation.Indicate the advantages and disadvantages of a staged implementation of automation for both the client and for the audit firm.(3 marks)* * END OF SECTION A * *(QUESTIONS)* * *SECTION B:ESSAY STYLE QUESTIONS (Total: 20 marks)Essay QuestionJohn Chan, an audit manager of a medium sized audit firm, has had a meeting with Ms Greta Bo, who is the major shareholder and managing director of The Greta Group. Ms Bo does not want to reappoint the group's existing auditors and has asked John Chan whether his firm would like to submit a proposal for the Group's 1999 audit.The Greta Group is a private group which runs twenty retail jewellery shops. Five of these shops are in the Mainland of the People’s Republic of China and are audited by a local PRC audit firm. Ms Bo does not want to change the auditors of these five shops.The Greta Group had liquidity problems in 1998 and their auditors modified their audit report by stating that the validity of the going concern assumption was dependent on the Group's bankers not withdrawing their credit facilities. The bankers are reviewing and extending their short term loans to the Group on a quarterly basis. Ms Bo wants to provide audited financial statements to the bankers as soon as possible and therefore requires that the 1999 audit be completed three weeks after the year end. Ms Bo is willing to pay an audit fee of $200,000, which John Chan reckons to be on the low side.John Chan knows that Ms Bo is a good friend of the mother of Bruce Lee, the senior audit partner of his firm. John Chan therefore asks Bruce Lee to determine whether the firm should accept the audit engagement.Required:On behalf of John Chan, draft a memorandum to Bruce Lee, the senior audit partner. In the memorandum:(1) You should identify the factors specific to The Greta Group, which Bruce Lee shouldtake into account when considering whether to accept the audit engagement. Y oushould also set out any additional information related to the factors you have identified that Bruce Lee may need to consider in order to make his decision. Your discussion should include, but not be limited to, the ethical issues of changing auditors.(13 marks) (2) With regard to the low audit fees and tight deadline, you should set out the informationto be obtained and arrangements to be agreed with The Greta Group before accepting the engagement.(4 marks) Style and presentation : A maximum of 3 marks will be awarded to candidates for style and presentation of their answers.(3 marks)* * END OF SECTION B * *(QUESTIONS)* * *SECTION C:CASE STUDY (Total: 30 marks)TeleMobile Limited (“TML”) is a subsidiary of a well known international mobile phone manufacturer and it acts as the group’s distribution centre for the greater China region. Taking advantage of industry growth in the region, sales of the company increased significantly over the year. However, it is only marginally profitable due to the group transfer pricing policy under which only a small margin is earned by TML. In addition to the core business, TML also holds listed investments in Hong Kong and China as long term investment. The operation of TML is financed largely by its holding company. The balance sheet of TML as at 30 November 1999 is summarized as follows:-30 November 1999 31 December 1998HK$’000 HK$’000 Fixed Assets 355 420Listed Investment 4,680 4,680Current AssetsInventories 23,795 19,753Accounts receivable 10,950 11,2252,369Cash 1,54533,34736,290Current LiabilitiesDue to group companies 30,670 25,3953,002Other payables 3,25328,39733,923Net Current Asset 2,3674,95010,050Capital Employed 7,402Satisfied by:-Share Capital 5,000 5,0005,050Retained Profits 2,40210,0507,402You are the audit manager in-charge of TML for the year ending 31 December 1999. In addition to your role as statutory auditor for TML, you are also required to report to the auditors of the holding company of TML for group reporting purposes. The group reporting deadline is extremely tight and you are required to issue your opinion to the auditors of the holding company by 15 January 2000.In order to meet the tight reporting deadline your strategy is to perform audit procedures on the accounts for the period ended 30 November 1999 and perform limited additional work for the month of December 1999. From prior year audit experience, you know TML’s internal control system is sufficiently reliable to support this approach. Your team members have completed audit field work for the 30 November 1999 accounts and you have reviewed the work performed. There are a number of outstanding matters but you are satisfied that the file is ready for review by the partner-in-charge. You discuss the issues arising from the audit with the partner who is satisfied that these have been satisfactorily resolved and that the additional work for the remaining one month should be minimal.While waiting for clearance of the outstanding matters and performing additional work on theaccounts for the month of December 1999, including the work on the stocktake which is scheduled to take place on 31 December 1999 and 1 January 2000, certain matters came to your attention which may have an impact on the conclusions previously drawn.Required:Discuss in each of the following situations the audit response and additional work (if any). Where appropriate, indicate also whether and how the wording of the audit report may have to be changed. You should consider each of these situation independently.Case Study Question 1When reviewing the result of the stocktake, you are satisfied that all the test count items agreed with the inventory list prepared by management. However, you noticed that the staff conducting the stocktake did not examine or obtain a copy of the control sheet of count tags from management.(8 marks) Case Study Question 2A major competitor of TML has recently launched a new product on the market which forced TML to lower its selling price substantially to maintain its competitiveness. Approximately 90% of the inventories as at 31 December 1999 would be affected by this price war.(8 marks) Case Study Question 3When performing the preliminary analytical review of the December results, you noted a significant increase in gross margins from 5% to 8%. The reasons given to you for the sudden increase in margins is that the December results included certain adjustments to correct accounting errors in the previous months, including instances where cost of sales was double-counted.(8 marks) Case Study Question 4As at the year end date, the market value of the listed investments of TML were significantly lower than its carrying value. TML’s accounting policy on long term investment is to state the investments at cost less any permanent diminution in value, and management is satisfied that there is no permanent diminution in any of these listed investments. Management has confirmed in the letter of representation that they intend to hold the investment for long term purposes and the temporary fluctuations in market price of these investments does not have any effect on their long term prospect. After reviewing all the available evidence, you concur with management’s view and have issued an unqualified opinion for group reporting purposes.While you are performing a post balance sheet review prior to the sign-off of the statutory accounts in February 2000, you notice that TML has disposed of all the listed investments and incurred a significant loss. You discuss the matter with management immediately and are advised that the disposal was to meet the immediate cash need of the holding company and that it had not been planned in the annual cash flow forecast.(6 marks)* * END OF EXAM PAPER * *(QUESTONS)。