Question Tag: Due diligence

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  • 10 Marks

AAA – Nov 2018 – L3 – Q5a – Audit-related services

Identification and explanation of due diligence assignments relevant to an acquisition.

Palm Oil Processing Company Ltd is a palm oil processing company founded in 2001. The processing is done at five different locations within the West Akim District of the Eastern Region. The company is facing a problem of the supply of palm fruits (the raw material of the company). To ensure regular supply of palm fruits, Palm Oil Processing Co. Ltd. approached the Directors of Ayensu Palm Plantations Ltd. to acquire their company. The Directors of Palm Oil Processing Company approached Western Auditors, a firm of Chartered Accountants, to conduct a due diligence review on Ayensu Palm Plantation Ltd.

Required:
As audit manager of Western Auditors:

i) Identify FIVE (5) practical examples of due diligence assignments and which one(s) would be relevant to Ayensu Palm Plantation Ltd. (5 marks)

ii) Explain FIVE (5) issues you would include in your due diligence review inquiries on Ayensu Palm Plantations Ltd. (5 marks)

i) Practical Examples of Due Diligence Assignments:

  1. Financial Due Diligence: A review of the financial position and obligations of a target to identify such matters as covenants and contingent obligations.
  2. Operational and IT Due Diligence: Assessing the extent of operational and IT risks, including the quality of systems, associated with a target business.
  3. People Due Diligence: Reviewing key staff positions under the new structure, contract termination costs, and the cost of integration.
  4. Regulatory Due Diligence: Reviewing the target’s level of compliance with relevant regulations.
  5. Environmental Due Diligence: Evaluating environmental, health, safety, and social issues in a target company.

(Any 5 points for 5 marks)

ii) Issues to Include in Due Diligence Review Inquiries on Ayensu Palm Plantations Ltd.:

  1. Structure: Including how the target is owned and constituted, and what changes will be necessary.
  2. Financial Health: Based on a detailed examination of past financial statements and an analysis of the existing asset base.
  3. Credibility of the Owners, Directors, and Senior Managers: Including validation of the career histories of all the main players in the business.
  4. Future Potential: Reflected in the strengths of its products or services and the probability of earnings growth over the medium to long term.
  5. Assessment of Risks: Including market risks, strategy risks, and potential future events that could impact the business.

(Any 5 points for 5 marks)

  • 10 Marks

AAA – May 2018 – L3 – Q2b – Practice management, Professional responsibility and liability

Discusses quality control standards for audit firms and the importance of procedures before accepting audit appointments.

i) The quality control standard for firms, ISQC 1: Quality control for firms that perform audits and reviews of financial statements and other assurance services engagements sets out standards and guidance that helps firms to comply with ethical, professional and legal requirements in the performance of audit and other professional assignments for the public.
Required:
At the firm level, recommend the elements that should be included in an audit firm’s system of Quality Control. (5 marks)

ii) You are a partner in Nii and Nana Associates, a firm of Chartered Accountants. You have just been nominated for the audit of Wine and Dine Ltd., a catering company in the twin-city. The company and its officers are not known to the firm. The company has just been incorporated and has not previously had an audit. You are about ready to accept the nomination.
Required:
Discuss why it is important for auditors to carry out procedures before accepting nomination for appointments. (5 marks)

The elements that should be included in an audit firm’s system of quality control at firm level as required by ISQC1 are as follows:

  • Firm and leadership responsibilities for quality within the firm:
    Personnel within the firm responsible for establishing and maintaining the firm’s system of quality control shall have an understanding of the entire text of the ISQC, including the application and other explanatory material, to understand its objectives and to apply the requirements properly. Firms are required to ensure that appropriate training is provided to ensure there is complete understanding of the objectives and procedures under ISQC1.
  • Human Resources:
    The firm’s overriding desire for quality will necessitate policies and procedures on ensuring excellence in its staff, to provide the firm with reasonable assurance that it has sufficient personnel with capabilities, competence, and commitment to ethical principles to perform engagements in accordance with professional standards and regulatory and legal requirements, and to enable the firm or engagement partners to issue reports that are appropriate in the circumstances.
  • Assignment of Engagement teams:
    The assignment of engagement teams is an important matter in ensuring the quality of individual assignments. This responsibility is given to the engagement partner.
  • Engagement Performance:
    The firm should take steps to ensure that engagements are performed correctly, that is, in accordance with standards and guidance. Firms often produce a manual of standard engagement procedures to give to staff so that they know the standards they are working towards. Ensuring good engagement performance involves:

    • Direction
    • Supervision
    • Review
    • Consultation
    • Resolution of disputes.
  • Monitoring:
    The standard states that firms should have policies in place to ensure that their quality control procedures are relevant, adequate, operating effectively, and complied with. In other words, they must monitor their system of quality control. Monitoring activity should be reported to the management of the firm on an annual basis for corrective action to be taken.

(5 points for 5 marks)

ii) The code of ethics for professional accountants requires that professional accountants or auditors accept only engagements which they are competent and capable of performing. In addition, they must ensure that they comply with the relevant statutory and legal requirements. It is therefore necessary for them to carry out procedures and consider the following factors:

  • They must consider whether they are professionally and legally qualified to accept the engagement.
  • They must consider whether there are any ethical issues that may confront them if they accept the nomination. Example: threats to the objectivity and independence.
  • They must consider whether they have the time and resources, including expert knowledge and skills, to serve the client.
  • They must consider whether they have been properly nominated and any outgoing auditor has properly parted with his client.
  • They must also fulfill the professional etiquette requirement of communication with the outgoing auditor, if any, as a sign of courtesy and to require information as to whether there are professional reasons for not accepting the nomination.
  • The procedures should also enable the auditors to determine whether the prospective client has integrity and falls within the risk appetite of the firm.
  • Therefore, on the whole, the procedures are carried out to enable the auditor to make an informed decision whether to accept or reject the nomination.

(Any 5 points for 5 marks)

  • 10 Marks

AAA – May 2018 – L3 – Q2a – Rules of professional conduct, Professional responsibility and liability

Comment on the ethical and professional issues in two cases related to audit client engagements.

Dzinpa & Associate, a firm of Chartered Accountants, in which you are a partner, has the following issues emerged in relation to two of its clients:

i) Good Life Insurance Company Limited is a major client and is listed on the Ghana Stock Exchange. The audit of this client has just started with an audit team of six members, of which Sally is the most junior. Sally has invested in a personal pension plan in a company whose investment portfolio is in all the listed companies on the Ghana Stock Exchange.

ii) You are the head of a team carrying out due diligence on Dumsor Ltd., a limited liability company which your client, Solar Electricals, is considering taking over. David, your second in command on the team, has confided in you that in the course of his work he has met the daughter of the Finance Director of Dumsor Ltd., and he intends to invite her on a date.

Required:
Comment on the ethical and other professional issues raised in the above matters.
(Note: Your answer should outline the threat arising, the significance of the threat, any factors you have taken into account, and if relevant, any safeguards you could apply to eliminate or mitigate the threat.) (10 marks)

(i) In relation to Good Life Insurance Ltd., there is a threat of self-interest arising, as a member of the audit team has an indirect financial interest in the client.

The relevant factors are:

  • The interest is unlikely to be material to the client or Sally, as the investment is recent and Sally’s interest is in a pool of general investments made by the pension scheme on her behalf.
  • Sally is the audit junior and does not have a significant role on the audit in terms of drawing audit conclusions or identifying audit risk areas.
  • The risk that arises to the independence of the audit here is not significant. It would be inappropriate to require Sally to divest her interest in the audit client. If all the elements of risk in this situation are to be eliminated, then the junior assigned to the team could be simply changed. However, such a step is not vital in this situation.

(Any 2 points for 2 marks)

(ii) In relation to Solar Electricals, two issues arise. The first is that the firm appears to be providing multiple services to Solar Electricals, which could raise self-interest threat. The second is that the manager assigned to the due diligence assignment wants to engage in a personal relationship with a person connected to the subject of the assignment, which could create familiarity or intimidation threat. (2 marks)

With regard to the issue of multiple services:

  • Insufficient information is given to draw a conclusion as to the significance of the threat. Relevant factors would be matters such as the nature of the services, the fee income, and the team members assigned to each. Safeguards could include using different staff for the two assignments. The risk is likely to be significant only if one of the services provided is audit, which is not indicated in the scenario.

In relation to the second issue, the relevant factors are these:

  • The assurance team member, David, has a significant role on the team as second in command.
  • The other party is closely connected to a key staff member at the company being reviewed.
  • Timing: In this situation, the firm is carrying out a one-off review of the company, and timing is a key issue. Presently David does not have a personal relationship which would significantly threaten the independence of the assignment. Therefore, the safeguard is to request that David does not take any action in that direction until the assignment is completed. If he refuses, then his removal from the team should be considered.

(3 points for 3 marks)

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