Acct 475 Midterm

MCGILL UNIVERSITY

Desautels Faculty of Management

MID-TERM EXAMINATION

PRINCIPLES OF AUDITING

ACCT 475-001

INSTRUCTIONS:

• This is a CLOSED BOOK examination.
• ONLY TRANSLATION dictionaries are PERMITTED.
• Noiseless non-programmable calculators are PERMITTED.
• READ BOTH THE QUESTIONS & EACH REQUIRED CAREFULLY.
• You are encouraged to use POINT form in your responses.
• This examination consists of 6 questions on a total of 9 pages including this cover page.  Please ensure that you have a complete examination paper before starting.
• The words 'End of Exam' appear on the last page.

Question 1. (15 Marks)

You are a manager in the audit firm of Smith and Jones and you have been appointed as a new team member to the audit of a jewellery shop named Wise Ltd. (WL).

WL is a family run business and has passed successfully into the third generation. They are the number one seller of engagement rings in Canada and have a reputation for premium products and ethically traded diamonds.

You have been asked to start the audit plan for WL by Tom Brown, a partner in Smith and Jones. Tom Brown has been the audit partner on this audit for the last 15 years. It holds sentimental value for him as this is where he bought his wife Daisy's engagement ring back in 1972.  You learn that Fred Ahern, your colleague, has already been a member of the audit team for the last four years and you recall Fred mentioning that he got a great deal on an engagement ring for his fiancé Meg from WL last Valentine's day.  The ring had a retail price of$15,000 but he due to his relationship with William White, the owner of WL only paid $5,000 for the ring.

You are looking forward to the spring break trip to the Bahamas that William White takes the audit team on in February, just after completion of the audit.

Lyle Lovette the tax partner says that this year the tax fee will be based on a percentage of the tax saved and not the normal annual fee of 000.

Required: Explain the ethical threats which may affect the audit of Wise Ltd. and for each threat discuss how its effect can be mitigated.

Question 2. (20 Marks)

Harp Ltd. (HL) operates a children's toy manufacturer outlet in Mont-Royal, Quebec.

Audit planning for the audit of the financial statements for the year ended December 31, 2011 has now commenced. The audit senior visited the client's premises and obtained the following information on the expected year-end trade receivable customer balances.

1. Management expects the year-end trade receivable balance to be approximately $1,500,000.  At this level, accounts receivable would make up 58% of the expected total net asset figure at the year-end.

2. Approximately 74% of the customer balances will be due from 3 major toy shops in Canada.

3. One of the company's largest customers was placed under bankruptcy protection on October 10, 2011.  At that date, the customer owed HL $258,164.  An audit senior's discussion with HL management estimates that no more than 10% could be recovered, the remaining balance would be uncollectible. At present it is unclear if the Courts will approve the bankruptcy, if it is not approved then it is likely that the company will be placed into liquidation. In the event of liquidation, HL would not receive anything for the amount owed.

4. The customer balances are due from approximately 250 customers. It is estimated that 225 of these are small toy shops. Due to the weak business environment, the period of credit taken by customers has increased from 45 days taken in 2010 to 95 days in 2011.

5. In addition to the trade receivable balances, the company made a loan of $525,000 to Best Toys Ltd. (BTL) in August 2011.  The loan will not be repaid until the end of June 2012. The ordinary shares of BTL and HL are fully owned by Mr. and Mrs. Jones who are also directors of both companies. The company made no other loans to directors or persons connected with directors. The net assets of HL for the year ended December 31, 2010 amounted to $3,900,000 and the financial statements for this same year were approved and released on the 28th of June 2011. The net assets of the company as at August 31, 2011 were $2,250,000.

Required:

a) With reference to the information obtained in relation to the trade receivable of HL, summarize your assessment of audit risk and draft the audit procedures you would propose in relation to the audit of trade receivable for the period under audit.

b) Based on the information provided in relation to the loan to BTL, draft a letter to the Directors of the company setting out the company financial reporting requirements that will need to be considered as part of the audit of this balance.

Your answer should deal specifically with:

i. any disclosures that the directors should consider including in the annual financial statements of the company, in relation to the loan;

ii. the consequences if the recommended disclosure is not made; and

iii. The impact of the loan on your obligation as Auditor to HL.

Question 3. (15 marks)

You are the auditor to Music Limited (ML). ML operates upscale sound system showrooms in Vancouver, BC. You have commenced planning the audit of the financial statements for the year-ended June 30, 2011 and you have ascertained the following information: