- 30 Marks
Question
You are the Principal Partner in charge of a four-partner firm of Chartered Accountants. Your firm has been invited to tender for the audit of Poles Apart Limited for the year ended 31 December 2013.
Poles Apart Limited was established two years ago and provides mobile phone service for individuals and businesses. The system established by the company comprises:
- Small portable mobile phones, which allow subscribers to contact or be contacted by any other telephone.
- The mobile phones can be used within the range of a local relay station that receives and sends calls to the mobile phone.
- The local relay stations are linked to a central computer that connects the calls to other users, often through a computer telephone network.
- Currently, the local relay stations cover one large city with a population of about 1,000,000. In the next year, the system will expand to all cities in Nigeria with populations over 250,000. By 2017, it will cover all motorways and cities with populations over 100,000, which will involve substantial capital expenditure and require additional borrowings.
- The cost of the relay stations and central computer is capitalized and amortized over six years.
- The mobile phones are manufactured by other companies and sold through retailers. Poles Apart Limited pays ₦2,000 to the retailer for each phone sold, which is capitalized and amortized over four years.
- Subscribers are invoiced monthly with a fixed line rental and a variable call charge. Charges for calls from other operators are also calculated by the company’s main computer.
- All shares are owned by three wealthy individuals who serve as non-executive directors. They receive a fixed allowance and do not plan further investment in the company.
- Establishing the network of relay stations and subscribers will result in losses for at least three years, with current borrowings at about 20% of shareholders’ funds. It is expected that the company will be highly geared by 2016.
- As the company will not be immediately profitable, executive directors receive a basic salary and a bonus based on the number of subscribers.
- The owners plan to float the company on the local Stock Exchange in 2016. The flotation will involve issuing new shares to the public and the three non-executive directors selling some of their shares.
- Poles Apart Limited has several large competitors, each with comprehensive coverage of over 90% of the population.
Required:
a. Consider the risks associated with the audit of Poles Apart Limited. (12 Marks)
b. Describe the ethical matters you should consider in deciding whether your audit firm should accept the audit engagement. This should include considering whether your firm has the technical and logistical ability to carry out the audit. (12 Marks)
c. Advise on whether you should accept or decline the audit assignment, giving your principal reasons for coming to this decision. (6 Marks)
Answer
Risks Associated with the Audit:
- Central Computer Reliability: The central computer is essential for relaying calls and billing subscribers, and any breakdown could be serious. Ensuring backup systems could mitigate this risk.
- Market Expansion: Expanding coverage may strain existing infrastructure and may require additional unforeseen capital for technology upgrades.
- Capitalization of Retailer Commissions: The ₦2,000 payment to retailers is capitalized, which may not comply with accounting standards if it doesn’t create a future economic benefit.
- Going Concern: High gearing and forecasted losses increase the going concern risk. If the company fails, the audit firm may face legal action.
- Client Pressure: Due to the client’s large size relative to the audit firm, they may pressure the audit firm to issue an unqualified opinion regardless of findings.
Ethical Matters in Accepting the Engagement:
- Independence: Given the potential large audit fee, the firm must assess if its independence could be impaired by financial dependence on the client.
- Technical Competence: The firm must evaluate if it has the necessary expertise in telecommunications and complex billing systems to audit accurately.
- Potential Legal Exposure: As a small firm auditing a rapidly growing and potentially high-risk company, there is an elevated risk of negligence claims, especially with plans for a stock exchange listing.
- Integrity of Management: The firm’s familiarity with the directors’ reputation is vital, particularly if they have prior associations with failed companies or issues of financial impropriety.
Decision on Engagement Acceptance:
- Accept with Precautions: If the firm believes it can mitigate independence and technical issues through additional resources or external support, it may consider accepting the engagement, ensuring rigorous documentation and adherence to professional standards.
- Decline Engagement: If the risks are deemed too high relative to the firm’s resources and capabilities, declining the assignment may be prudent to avoid reputational and legal risks.
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