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							                                  BROCK UNIVERSITY

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Mid-Term 1: Winter 2012                              Number of Pages: 12

Course: ACTG 3P11                                    Number of Students:180
                                                     Instructor:
Examination Date: February 17, 2012                  Ian L. Adamson

Location:




            Question        1         15
                            2         10
                            3         10
                            4         10
                          Bonus       1
              Total                   55



Name:

Student Number:
Section Number:
Accounting 3P11                     Mid-Term 1 Winter 2012                                2 of 10



Question 1: (15 marks)

Cassette Productions Limited has had declining sales as more and more media are being
presented on CD and DVD rather than video or streaming cassette. They diversified their
business by moving into backup systems, but are still having trouble boosting their income.
    The audit team was led by Theresa Sanford, who obtained her CA last year. Theresa had two
assistants, Marv and Uhta, who did the work in the accounts receivable and inventory area.
Theresa felt that they did not require supervision, as they had been with the firm for two years,
and were expected to do well on their professional exams this year. Marv found that the accounts
receivable had many old accounts, and customers were tough to get hold of. Accordingly, he
decided to accept management's representations with respect to the balances. Similarly, Uhta
noted that there were still many cassettes in inventory that had been there for over three years.
Management insisted on recording these at cost, since they were looking at software that would
allow these tapes to be used by computer systems rather than music systems. Uhta accepted
managements' valuation.
    Two months after the audit report was issued, Cassette Productions Limited went bankrupt. It
was found that many accounts receivable were for fictitious customers, and the receiver was only
able to obtain five cents on the dollar for the inventory, which was sold as scrap.
    The bank is suing the auditors to recover its bank loan, which had been renegotiated based
upon the results of the financial statements.

Required: Will the bank be successful in its suit? Why or why not?

      The bank may be successful (S) for the following reasons:
       1. The bank is owed a duty of care (DC)
       2. If the bank is a foreseeable user of the F/S (FU)
       3. Thus the bank is a limited class (LC) (Haig vs. Bamford) (HB)
       4. The F/S were materially misstated (MM)
       5. Thus there was a breach of the duty of care (BDC)
       6. Audit was not done according to GAAS (not GAAS) due to:
                a. Lack of supervision (LS)
                b. Lack of appropriate audit evidence (LAE)
       7. IF work was done according to GAAS the errors would have been detected (If
           GAAS)
       8. Thus the auditors were negligent (N)
       9. The bank suffered a loss (L)
       10. The bank would probably be able to link the loss to reliance on the F/S (L&R), that
           is, the breach caused the loss.

       On the other hand, if the bank is not a foreseeable user (NFU) it will not be successful.
       (NS)
Accounting 3P11                Mid-Term 1 Winter 2012                           3 of 10




                  Explanation of Marking Key – each worth one mark
S                                          Successful
DC                                         Duty of care
FU                                         Foreseeable user
LC                                         Limited class
HB                                         Haig vs. Bamford
MM                                         Materially misstated
BDC                                        Breach of the duty of care
Not GAAS                                   Done according to GAAS
LS                                         Lack of supervision
LAE                                        Lack of appropriate audit evidence
If GAAS                                    If work done according to GAAS
N                                          Negligent
L                                          Suffered a loss
L&R                                        Link loss to reliance
NFU                                        Not foreseeable user
NS                                         Not successful
Accounting 3P11                     Mid-Term 1 Winter 2012                                  4 of 10




Question 2: (10 marks)

Discuss the differences and similarities between the roles of accountants and auditors. What
additional expertise must an auditor possess beyond that of an accountant?

Accountants:

      To record (1), classify (1), and summarize economic events (1) in a logical manner
      This provides financial information for decision making (1)
      Thus accountants must have a thorough understanding of GAAP (1)

Auditors:

      To determine if the financial information prepared by accountants properly reflects
       economic events that have occurred (1)
      Thus auditor must have a thorough understanding of GAAP (1)
      Auditor must have expertise in gathering (1) and evaluating evidence (1) in accordance
       with GAAS (1)
Accounting 3P11                        Mid-Term 1 Winter 2012                                 5 of 10




Question 3: (10 marks)

Each of the following situations involves a possible violation of the provincial institutes' Rules of
Professional Conduct. For each situation, (1) decide whether or not the Rules have been violated,
and (2) briefly explain how the situation violates (or does not violate) the Rules.

A) Johnny Line has a successful dentistry practice in Calgary. Johnny has recommended one of
his patients to Leslie King, public accountant. To show gratitude for the referral, Leslie has
agreed to pay Johnny 5% of the fee for audit services rendered by Leslie to Johnny's patient.
Leslie discloses the payment agreement to her new client.

   Violation?   Yes (1) No
   Explanation:

      Payment of a referral fee (1)




B) The accounting firm of Bayer & Peng, public accountants, is negotiating a fee with a new
audit client. They agree the client will pay $75,000 if Bayer & Peng issues a clean, unqualified
opinion, $50,000 if a qualified opinion is issued, $40,000 if an adverse opinion is issued, and
$10,000 if a denial of opinion is issued.

   Violation?   Yes (1) No
   Explanation:

      A contingent fee is prohibited (1)
Accounting 3P11                      Mid-Term 1 Winter 2012                                   6 of 10




C) Don Smith, public accountant, takes part in the audit of Shaw Corporation. Don is not a
partner or a manager in the public accounting firm, and does not own any stock in Shaw
Corporation. Don's five year-old daughter, Betty Lou, received one share of Shaw Corporation's
common stock for her fifth birthday. The stock was a gift from Betty Lou's grandmother. Betty
Lou treasures that share of stock and is absolutely unwilling to part with it.

   Violation?   Yes (1) No
   Explanation:

      Audit participants are prohibited from having a financial interest in a client (1/2)
      The same applies to the participant’s dependent (1/2)




D) Samantha Matthews, public accountant, is a partner in the Vancouver office of Dell & Bates,
PAs. Samantha's brother is employed as the chief financial officer of Scotch Appliances, a large,
publicly-held company in Toronto. Scotch Appliances is one of Dell & Bates' audit clients.
Neither Samantha nor the Vancouver office of Dell & Bates is involved in the audit of Scotch
Appliances.

   Violation?   Yes (1) No
   Explanation:

      Independence is impaired (1/2)
      A close relative is employed by the client in a position of influence (1/2)
Accounting 3P11                      Mid-Term 1 Winter 2012                               7 of 10




E) On August 5, 2010, Page Dane, public accountant, issued the audit report on Borhut
Corporation's June 30, 2010 financial statements. On August 30, 2010, Borhut paid Page's audit
fee with stock rather than cash. Page sold the stock on September 15, 2010, two months prior to
the beginning of the planning phase for the audit of the June 30, 2011, financial statements.

    Violation?   Yes (1) No
    Explanation:

       Public accountants are prohibited from owning stock in a client (1)
.
Accounting 3P11                       Mid-Term 1 Winter 2012                               8 of 10




Question 4: (10 marks)

In May 2006, the firm of Chang and Crown (C&C) became the auditors of Laua Limited (LL)
for the fiscal year ended December 31, 2005. LL's Board of Directors approved the change from
its previous audit firm on the recommendation of LL's senior management. One of the new board
members is a bit confused about management's role with respect to the financial statements and
thought that Chang and Crown would be preparing the financial statements. He was also glad
that the auditors would be able to help prevent illegal acts and fraud.

Required:

   A) Distinguish between management's responsibility and the auditor's responsibility for the
      financial statements under audit.

Management Responsibility:

      F/S fair presentation (1)
      Adequate system of internal control (1)
      Appropriate accounting policies (1)




Auditor responsibility:

      Plan and perform the audit with due care (1)
      Attitude of professional skepticism (1)
      Finding material error (1), if it exists (at the appropriate level of audit risk)
      Audit report (1)
Accounting 3P11                       Mid-Term 1 Winter 2012                          9 of 10




   B) Explain to the board member why the auditor does NOT help prevent illegal acts and
      fraud. What is the role of the auditor with respect to illegal acts and fraud?


Management is responsible for the system of internal control (1)
Internal controls are designed to prevent and detect illegal acts, fraud etc. (1)

Auditors only consider illegal acts and fraud that are material to the F/S (1)
Thus only consider that F/S are free of material misstatements (2)
These misstatements include material illegal acts and material fraud (1)
Auditors do not give absolute assurance, i.e. 100%, with regards to these items (1)
Only give a level of probability (1)
Accounting 3P11                   Mid-Term 1 Winter 2012   10 of 10



Optional Bonus Question: (1 mark)

What is the name of the following landmark?




The Westminster Clock Tower.