BKAA 2013 AUDITING AND ASSURANCE I

SECOND SEMESTER 2017/2018 (A172)

GROUP A
INDIVIDUAL ASSIGNMENT

CASE 3: NEW CLIENT, LEGAL LIABILITY AND

MATERIALITY

PREPARED FOR:
Dr. BASARIAH BINTI SALIM

PREPARED BY:
KHOR YEE HOO0I (247740)

SUBMISSION DATE
13th MAY 2018
QUESTION 1:
What is a typical process involved in accepting a new audit client?

There are two phases will involve in accepting a new audit client which are:

a) Before accepting a new audit client

 IFAC’s Code of Ethics for Professional Accountants stated that before accepting a new
client relationship, a professional accountant in public practice shall determine whether
acceptance would create any threats to compliance with the fundamental principles.

 When approached to take on a new client, the firm should investigate the potential client,
its owners and business activities to evaluate whether there are any questions over the
integrity of the potential client which create unacceptable risk. These investigative
actions are usually performed as ‘know your client’ or ‘customer due diligence’
procedures, which are also carried out to comply with anti-money laundering
regulations.

b) After a client has been accepted

 The auditor should prepare an engagement letter to clarify the expectation and
responsibilities of both party.

 Next, audit firm should have a good relationship and understanding with the client’s
business and accounting system.

 Also, the auditors should engage in the discussions with the management and the audit
staff who have been previously engaged on the audit.

 The next process is assessing the client’s business risk. The primary concern of the
auditors is the risk of material misstatements in the financial accounts due to client’s
business risk.
 Furthermore, audit firm will conduct preliminary analytical procedures. The aim of
conducting preliminary analytical procedures is for auditors to get a better
understanding of the client’s business.

 Auditor shall develop an overall audit strategy or an audit plan that sets the timing,
scope and direction of the audit, which will be used to guide the development of the
audit plan.

 Lastly, the auditors must be documented all aspects of the planning process which
including the overall audit strategy, the audit plan and any changes made during the
audit engagement to the audit plan or the overall audit strategy and the reasons for such
changes.
QUESTION 2
What is the purpose of peer review? Why have peer reviews become necessary? What
does the peer review team commonly examine?

Peer review is the evaluation of work by one or more people of similar competence to the
producers of the work (peers). It constitutes a form of self-regulation by qualified members of
a profession within the relevant field. The purpose of peer reviews is to maintain standards of
quality, improve performance, and provide credibility in the accounting and auditing services
provided by CPA firms. Peer reviews become necessary because peer reviews ensure that CPA
firms are preforming at a high standard and offer firms opportunities to improve the quality of
their services and processes. As a member of the American Institute of Certified Public
Accountants (AICPA), firms are required to have an outside peer review of quality control
procedures every three years. Licensed CPAs who meet specific requirements and have
completed the proper training can become a peer reviewer. The requirement to become a peer
reviewer include:

 Be a member of the AICPA in good standing, licensed to practice as a CPA.

 Be currently active in public practice at a supervisory level in the accounting or auditing

function of a firm enrolled in the program, as a partner of the firm, or as a manager or
person with equivalent supervisory responsibilities.

 Be associated with a firm that has received a report with the peer review rating of pass
for its most recent System or Engagement Review that was accepted timely, ordinarily
within the last three years and six months.

 Possess current knowledge of professional standards applicable to the kind of practice

to be reviewed, including quality control and peer review standards.

 Have at least five years of recent experience in the practice of public accounting in the
accounting or auditing function.
QUESTION 3
What kind of information is expected from the meeting and discussion between Emran
& Suraya audit firm partners with the predecessor auditor of WAFA Berhad?

The information which can gain from meeting are as below:

a) the predecessor auditor’s evaluation of the integrity of the management of the potential
client.

b) Next, Emran &Suraya knows the predecessor auditors reveal any disagreement with
management as to accounting principle or other significant matters.
 For example, the management said that the RM3.46 million of receivable was
recoverable but predecessor auditor claimed that the RM 3.46 million of receivable had
been outstanding for a long time and was not impaired. During the discussion, the
predecessor auditors also provide some information regarding potential litigation issue
by Bank Teras Malaysia.

c) The predecessor could provide the most recent audited financial statement and the prior
years’ audit documentation for review purpose to obtain sufficient appropriate audit
evidence.
 The auditor need to review the information that relating to audit procedure performed
on the current period’s transaction as they need to provide sufficient evidences which
is a reasonable basis for expressing an opinion on the financial statement based on the
engagement to audit, including evaluating the application of accounting principles. It
will eventually affect the current period financial statements if the auditors obtain audit
evidence that the previous balances contain of misstatement.
QUESTION4
What actions should be taken by Emran & Suraya audit firm partners if the predecessor
auditor is reluctant to meet them?

a) request the permission from the client before communication can be made to the
predecessor auditor
 Based on the confidentially requirement in the MIA By-Laws on Professional Ethics,
Conduct and Practice requires that the successor auditor should request the permission
from the client before communication can be made to the predecessor auditor. The
auditor is precluded from disclosing confidential information obtained in the course of
an engagement unless the client specifically consents. So, Emran and Suraya can write
the formal letter to ask the WAFA Berhad to authorize the Raudah & Partner to respond
fully to the Emran & Suraya’ inquiries and the predecessor auditor is required to
respond to the Emran & Suraya 's request for information.

b) Emran & Suraya audit firm can counsel with their legitimate consultant to discuss and
decide an appropriate course of further action if the predecessor auditor is reluctant to meet
them.

c) Emran and Suraya can create a Client Screening Team. The Client Screening Team can
make the ultimate decision as whether the firm should actively seek a particular audit.
They would then review all the audit documentation and instruct the partner as to the
appropriate course of action.
QUESTION 5
Emran & Suraya has to tackle the materiality issues in question when forming its year
2016 audit opinion. How do auditors evaluate the materiality of an item in a specific
engagement? Do you think that the non-impairment of receivables amounting to RM3.46
million and RM6 million loans from Bank Teras Malaysia was actually material to
WAFA Berhad?

There are three steps for auditors to evaluate the materiality of an item in a specific engagement,
which are set preliminary judgement about materiality, allocate preliminary judgement about
materiality to segments and estimate misstatement and compare with preliminary judgement.

a) set the preliminary judgement

This process can help the auditors to plan appropriate evidence to accumulate. Auditors
often revised the judgement about materiality if there are changes in the factors either
quantitative or qualitative factors that used to determine the preliminary judgement.

b) allocate preliminary judgement about materiality to segment is necessary.

This will help auditors to decide the appropriate evidence to accumulate for each account.
In addition, the allocation also can minimize audit cost without sacrificing audit quality.
The auditor has to ensure that all the combined misstatement in all account are almost
equal to the revised judgment about materiality.

c) Estimation on misstatement and comparison with preliminary judgement

It results from performing audit test by auditors. When auditors perform audit procedure
for each segment of the audit, they document all misstatement found. Misstatement in
account can be categories into known misstatement and likely misstatement. After that,
the auditors would combine all the misstatement for each account found on the worksheet
and compare with the materiality.
 In my opinion, the non-impairment of receivable amounting to RM3.46 million is
material to WAFA Berhad due to the argument between the director and the auditor regarding
the recognition. Raudah & Partner claimed that the RM3.46 million of receivable should be
impaired since it had been outstanding for a long time. This will cause the financial statement
became inaccuracy in where the amount of RM3.46 million is not recognised according to the
accounting standard. The materiality of RM 3.46 million receivables can be evaluated
according to the preliminary judgement that set by the auditor in earlier.

Besides, for the RM 6 million, it is material to WAFA Berhad due to respond of third
parties. In the case, Bank Teras Malaysia was overlooked the audited financial report of WAFA
Berhad in which the bank decided to extend the loan to WAFA Berhad. However, the bank is
in doubts about the financial conditions of WAFA Berhad due to the qualified audit report that
issued by the predecessor auditor. As a result, an investigation was carried out by the bank and
it lead to the bank to take legal action to sued the formal external auditor and WAFA Berhad.
The consequent action of Bank Teras Malaysia may prove that the WAFA Berhad may not
able to repay the loan in full amount at the maturity date. Thus, this proved that RM 6 million
loan is material to WAFA Berhad as it caused the bank to change it decision after realized the
real condition of the company.
.
QUESTION6
What are examples of quantitative and qualitative factors to be considered by auditor in
determining the preliminary judgement about materiality?

The auditor should evaluate whether uncorrected misstatements are material, individually or in
combination with other misstatements. In making this evaluation, the auditor should evaluate
the misstatements in relation to the specific accounts and disclosures involved and to the
financial statements as a whole by taking into account relevant quantitative and qualitative
factors Examples of qualitative factors to be considered by auditor in determining the
preliminary judgement about materiality:

a) The significance of the misstatement or disclosures relative to known user needs, for
example, the magnifying effects of a misstatement on the calculation of purchase price
in a transfer of interest or the effect of misstatements of earnings when contrasted with
expectations.

b) The effect of the misstatement on segment information, for example, the significance
of the matter to certain segment important to the future profitability of the company,
the impact of the matter on trends in segment information, all in relation to the financial
statements taken as a whole.

c) A misstatement that has the effect of increasing management's compensation, for

example, by satisfying the requirements for the award of bonuses or other forms of
incentive compensation.

d) The sensitivity of the circumstances surrounding the misstatement, for example, the
implications of misstatements involving fraud and possible illegal acts, violations of
contractual provisions, and conflicts of interest.

e) The motivation of management with respect to the misstatement, for example, an

indication of a possible pattern of bias by management when developing and
accumulating accounting estimates or a misstatement precipitated by management's
continued unwillingness to correct weaknesses in the financial reporting process.
 Besides, there are some examples of qualitative factors to be considered by auditor in
determining the preliminary judgement about materiality:

a) Users of the financial statements. For example, creditors, stockholders, suppliers,

employees, customers, regulators.

b) Size of financial statement elements. For instance, current assets, current liabilities,
total assets, total revenues, net income. Total assets or total revenues are better bases
for determining materiality for many entities because these factors are more stable and
less variable from year to year than is net income. Difficulties arise when using net
income, or a variant of net income, as a base when the entity is close to breaking even
or experiencing a loss.

c) Change in trend of earnings, revenues, cash flows. For example, the change may be
material where the reported income was increase 5% annually over the past 3 years but
the current year income was declined for 1%.
QUESTION 7
What is the meaning of “materiality is a relative rather than absolute concept” in the case
of WAFA Berhad?

Materiality is a relative rather than an absolute concept which means that when auditor assesses
whether an item is material or otherwise, he or she needs to use their professional judgment to
decide. Materiality threshold is dependent specifically on the client situation. Uses of
benchmarks are needed for evaluating materiality. Types of bases used in evaluating a
materiality such as nature and amount of an item. The qualitative factors also will affect
materiality decisions. For example: amount involving fraud, misstatement arising from
contractual obligation and the misstatement might be due to change of trend. While, if its
omission or misstatement could influence the economic decisions of users taken on the basis
of the financial statements.

From the case can prove that materiality is a relative rather than an absolute concept.For
instances, there is a materiality on the balance of account receivables. Raudah & Partner issued
a qualified audit opinion on group’s financial statements due to non-impairment of receivables
amounting to RM3.46 million. They claimed that the RM 3.46 million of receivables should
be impaired or written as bad debt since it had been outstanding for a long time. It will highly
affect the accuracy of the financial statement where the amount of RM 3.46 million is not
recognised according to the accounting standard. They give a true and fair view of financial
position, financial performance and cash flows for the financial year of the group and the
company.

Besides, an investigation carried out by Bank Teras Malaysia discovered that WAFA
Berhad’s RM250million total assets figures included RM50million if non-existing overseas
debtors. So,the bank has sued the former external auditor for negligence and also WAFA
Berhad for the fraud. Moreover, it is material for that RM6 million to WAFA Berhad due to
respond of third parties. From the case, Bank Teras Malaysia was overlooked the audited
financial report of WAFA Berhad in which the bank decided to extend the loan to WAFA
Berhad.