You are a senior manager in Macau & Co, a firm of Chartered Certified Accountants. In

your capacity as engagement quality control reviewer, you have been asked to review the audit files of Stanley Co and Kowloon Co, both of which have a financial year ended 31 December 2015, and the audits of both companies are nearing completion.

(a) Stanley Co is a frozen food processor, selling its products to wholesalers and supermarkets. From your review of the audit working papers, you have noted that the level of materiality was determined to be $1·5 million at the planning stage, and this materiality threshold has been used throughout the audit. There is no evidence on the audit file that this threshold has been reviewed during the course of the audit.

From your review of the audit planning, you know that a new packing machine with a cost of $1·6 million was acquired by Stanley Co in March 2015, and is recognised in the draft statement of financial position at a carrying amount of $1·4 million at 31 December 2015. The packing machine is located at the premises of Aberdeen Co, a distribution company which is used to pack and distribute a significant proportion of Stanley Co’s products. The machine has not been physically verified by a member of the audit team. The audit working papers conclude that ‘we have obtained the purchase invoice and order in relation to the machine, and therefore can conclude that the asset is appropriately valued and that it exists. In addition, the managing director of Aberdeen Co has confirmed in writing that the machine is located at their premises and is in working order. No further work is needed in respect of this item.’

Inventory is recognised at $2 million in the draft statement of financial position. You have reviewed the results of audit procedures performed at the inventory count, where the test counts performed by the audit team indicated that the count of some items performed by the company’s staff was not correct. The working papers state that ‘the inventory count was not well organised’ and conclude that ‘however, the discrepancies were immaterial, so no further action is required’.

The audit senior spoke to you yesterday, voicing some concerns about the performance of the audit. A summary of his comments is shown below:

‘The audit manager and audit engagement partner came to review the audit working papers on the same day towards the completion of the audit fieldwork. The audit partner asked me if there had been any issues on the sections of the audit which I had worked on, and when I said there had been no problems, he signed off the working papers after a quick look through them.

When reading the company’s board minutes, I found several references to the audit engagement partner, Joe Lantau. It appears that Joe recommended that the company use the services of his brother, Mick Lantau, for advice on business development, as Mick is a management consultant. Based on that recommendation, Mick has provided a consultancy service to Stanley Co since September 2015. I mentioned this to Joe, and he told me not to record it in the audit working papers or to discuss it with anyone.’

Required:

Comment on the quality of the audit performed discussing the quality control, ethical and other professional issues raised. (13 marks)

(b) Kowloon Co works on contracts to design and manufacture large items of medical equipment such as radiotherapy and X-ray machines. The company specialises in the design, production and installation of bespoke machines under contract with individual customers, which are usually private medical companies. The draft financial statements recognise profit before tax of $950,000 and total assets of $7·5 million.

The audit senior has left the following note for your attention:

‘One of Kowloon Co’s major customers is the Bay Medical Centre (BMC), a private hospital. In June 2015 a contract was entered into, under the terms of which Kowloon Co would design a new radiotherapy machine for BMC. The machine is based on a new innovation, and is being developed for the specific requirements of BMC. It was estimated that the design and production of the machine would take 18 months with estimated installation in December 2016. As at 31 December 2015, Kowloon Co had invested heavily in the contract, and design costs totalling $350,000 have been recognised as work in progress in the draft statement of financial position. Deferred income of $200,000 is also recognised as a current liability, representing a payment made by BMC to finance part of the design costs. No other accounting entries have been made in respect of the contract with BMC.

As part of our subsequent events review, inspection of correspondence between Kowloon Co and BMC indicates that the contract has been cancelled by BMC as it is unable to pay for its completion. It appears that BMC lost a significant amount of funding towards the end of 2015, impacting significantly on the financial position of the company. The manager responsible for the BMC contract confirms that BMC contacted him about the company’s financial difficulties in December 2015.

The matter has been discussed with Kowloon Co’s finance director, who has stated that he is satisfied with the current accounting treatment and is not proposing to make any adjustments in light of the cancellation of the contract by BMC. The finance director has also advised that the loss of BMC as a customer will not be mentioned in the company’s integrated report, as the finance director does not consider it significant enough to warrant discussion.

Kowloon Co is currently working on six contracts for customers other than BMC. Our audit evidence concludes that Kowloon Co does not face a threat to its going concern status due to the loss of BMC as a customer.’

Your review of the audit work performed on going concern supports this conclusion.

Required:

(i) Comment on the matters to be considered, and recommend the actions to be taken by the auditor; and (7 marks)

(ii) Explain the audit evidence you would expect to find in your review of the audit working papers. (5 marks)