Read the information on “Valuable Jewellery Ltd.”. Valuable Jewellery Ltd. You a
ID: 2584091 • Letter: R
Question
Read the information on “Valuable Jewellery Ltd.”.
Valuable Jewellery Ltd.
You are the audit manager of a Hong Kong CPA firm, Lee and Young. Your firm has recently been engaged as the auditor of Valuable Jewellery Ltd. (Valuable Jewellery) and will be conducting the audit for the year ended 30 June 2016. Valuable Jewellery is a company incorporated in Hong Kong and is engaged in the manufacture and trading of a wide range of jewellery. Its products are mainly sold to local customers and mainland tourists in Hong Kong.
During the planning stage of the audit, you discovered the following:
1) Valuable Jewellery was established 30 years ago by Mr Tse, a man who is highly respected in the jewellery business and internationally known for his jewellery designs and gem valuation expertise. Mr Tse remains the Managing Director of the company and holds 80% of its issued share capital. Mr Tse’s two daughters, Delphine and Daphne, each hold 10% of the remaining shareholding and are also executive directors on the Board of Directors.
(2) Valuable Jewellery’s previous auditor was a sole practitioner who unfortunately died from a heart attack last year. Your CPA firm was introduced to Mr Tse through his son-in-law, who is currently the administrative manager of your CPA firm, Prior to l 15 engagement, your CPA firm had never been involved with companies in the Jewellery industry.
(3) Valuable Jewellery’s had unmodified(clean) audit reports issued by its previous auditors from the start of the business.
(4) With the economic recovery, there has been a sharp increase in the company’s sales for the year under review. To cope with such an increase in demand, two new shops, one located in Tsim Sha Tsui and another in Macau, were opened during the year in addition to the main shop in Central.
(5) All high value gems were kept by Mr Tse in his private safe in the main shop. When certain gems were needed for a particular design, Mr Tse would take his gem collections out and pick the appropriate pieces. He would then decide the cost allocation of the designed jewellery.
Answer the following questions.
(a) Since Valuable Jewellery is a new audit client, you would have considered some issues/undertaken some actions before you agreed to accept this new client. Identify and discuss one potential independence issue and one competency issue that you should have considered. (6 marks)
(b) In performing the planning of the audit of Valuable Jewellery, you need to perform risk assessments by identifying factors that may increase or decrease the risk of material misstatement. (7 marks)
(i) Briefly define the two components that is part of risk of material misstatement (RMM).
(ii) Discuss why auditors perform risk assessments.
(c) Regarding the case of Valuable Jewellery, identify and discuss four factors or issues that you would consider when you assess the risk of material misstatement at the financial statement level. (8 marks)
(d) Assume that during the audit, you found out that the Macau store was leased from Mr Tse’s wife. You also found out that the amount being paid was two times the market price of similar rental properties. Mr Tse refuses to disclose this related party transaction in the notes to the financial statement. The amount involved is considered material but not very material. Identify the audit opinion you think is the most appropriate and justify your choice. (4 marks)
Explanation / Answer
(a) The independence issue that the CPA firm could face and shoud have considered is that the Mr. Tse(Major shareholder of the client Co) relative ie his son in law can try to influence the opinion of the engagement partner, and the competency risk is that the CPA firm has never been involved with the audit of the companies in jewellery industry which can affect its audit planning procedures, Sampling procedures and collection of evidences and drawing conclusion.
(b)(i)The Risk of Material Mistatement is the risk that the financial statements are materialy mistated before the audit. The 2 components of RMM are : Inherent Risk and Control Risk. They both arise at the level of Mgt and CPA can only assess it and not frame this kind of risk, which is different from detection risk. Detecton risk is the risk that material misstatements may occur and control risk is that Internl Control of the client may not operate as desired.
(ii) The auditor performs risk assessment because if the client has good Internal control systems and Inherent risk and control risk are evaluated to be reasonably low, the audior would have to respond less to substansive procedures , but this lead to increase in detection risk.
And if inherent risk and control risk are high, detection risk is low ince the auditor would perform extended procedures for detecting any material misstatment and fraud.
(c)In risk assesssment the auditor has to check the following factors at the financial statement level (1) Mgt Integrity (2) Mgt Expereience and Knowledge (3) Nature of Entity's Business and (4) Factors affecting the clients idustry
(d) Note: There is a confusion whether the amount involved is material or not material ?
Assuming the amount to be material but not pervasive (since it affects only one transaction), as auditor i would give a unqualified report except the fact that the mgt has not disclosed a related party transaction with Mr. Tse's Wife and the rent was twice the market price.
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