Identify the Business Risks at Sunshine.

Question 1 a) There are eight business risks which should be assessed by the management of Sunshine. Exclusive right risk In July 2009, Sunshine obtained exclusive rights to operate a car and passenger ferry route between Hong Kong and Shekou until December 2025. It about only 15 years exclusive right, it is relative short. Besides, it may be cancel in the future. Sunshine facing cannot extend the exclusive right risk. Entrance of competitor risk Between Hong Kong and Shekou has an alternative to driving 300 kilometers using the road. There have been several ambitious plans to build a bridge crossing Hong Kong to Shekou in the future, but they have failed due to lack of public support and the government funds only. If the road is build, then it will be a high business risk for Sunshine, since using the road is faster than boats. Sunshine is facing entrance of competitor risk in the future. Old boats risk Sunshine refurbished two 20-year-old boats to service the route. In this case, Sunshine facing boats are relatively old. Old boats need higher repair and maintenance costs in order to operate the business. Environmental Protection Regulations risk The boats have no yet met the emission standards of the Environmental Protection Regulations which will come into force in 2015. Sunshine should be update the old boats or buy new boats. Both suggestions need a very high cost for Sunshine to meet Environmental Protection Regulations. Unused capacity risk Each boat makes three return crossings every day of the year, subject to weather conditions. Each has the capacity to carry 250 passengers and 40 vehicles. Sunshine carried 70,000 vehicles in the year ended 31 December 2013(2012:58,000; 2011:47,000). According to above, capacity to carry vehicles is 3×2×40×365=87600 vehicles. Sunshine has over unused capacity during 2011-2013. Franchise risk Hot and cold refreshments and travel booking facilities are offered on the one-hour crossing. These services are provided by independent businesses on a franchise basis. The services quality very depends on the suppliers. Besides, extra income is not subject to Sunshine. Oil cost risk Oil cost will be affected by global environment, such as, required of oil consumption, objectives and needs, current and future business environment etc. So it may be rise or drop dramatically. The cost of oil may be very unstable. Weather risk Sunshine is facingpotential financial losses caused by unusual weather. Besides, it may be leading to shipwreck. Weather is an important element for boats industry. b) The risks identified in (a) could be managed and maintained at an acceptable level by Sunshine. Show as following: Exclusive right risk Sunshine should be maintain a good relationship with customers and good brand name in order to obtain the exclusive right to operate a car and passenger ferry route between Hong Kong and Shekou for a long time more easily. Besides, it can reduce the entrance of competitor. Thus, exclusive right will be not taken by another company. Entrance of competitor risk Sunshine should be built up their brand name in order to retain customer. Promote comfortable, conveniences and cheaper for customer. Besides, keep profession customer service and maintain good customer relationship in order to defense the entrance of competitor. Old boats risk Old boats facing old machine problem, then it may be suddenly have some accident, thus Sunshine should be keep more frequency on repair and maintenance, in order to avoid the accident. Environmental Protection Regulations risk New Environmental Protection Regulations will be effect in 2015, Sunshine cannot avoid the event. Besides Sunshine can prepare early, because the cost of met the emission standards of Environmental Protection Regulations will be more expensive when near the regulation effect in 2015. On the other hand, early to improve the boats emission standard are more elasticity and cheaper. Unused capacity risk Unused capacity is an opportunity cost for the company, Sunshine should utilize the opportunity cost, and thus some of place can transport goods in order to utilize all unused capacity. Franchise risk Sunshine should be directly manages hot and cold refreshments and travel booking facilities, so Sunshine can easy to maintain the quality of services in order to keep the brand loyalty. Besides, Sunshine can earn extra income from the hot and cold refreshments and travel booking facilities. Thus, don’t use franchise basis. Oil cost risk Oil cost will be affected by global environment, so implementation of an oil price risk strategy is needed. Sunshine can besthedgeagainst costly exposures to oil price risk.The best method is use oil price risk management services in order to decrease the oil cost risk. Weather risk Weather risk may be lead to Sunshine facing financial impact, so Sunshine should be use risk transfer instruments based on a defined weather element, such as temperature, rain, snow, wind, etc. in order to decrease the financial exposure due to the weather problem. Thus, Sunshine should buy insurance to cover the potential loss. c) Business risk identified in (a) may be linked to a financial statement risk. Show as following, Exclusive right risk The exclusive right risk will be affect Sunshine going concern problem, because cannot obtain the exclusive right will be close the business Entrance of competitor risk Build a road crossing Hong Kong to Shekou will be decrease Sunshine’s revenue, because one more method crossing Hong Kong to Shekou. Old boats risk Old boats will increase repair and maintenance expenses. Environmental Protection Regulations risk Government Environmental Protection Regulations will lead to increase repair and maintenance expenses. Unused capacity risk Unused capacity will lead to decrease Sunshine’s revenue. Franchise risk Franchise basis may be decrease revenue, because supplier provides bad services and goods. Oil cost risk Oil cost increase may be increase material expense. Weather risk Unstable weather may be lead to decrease revenue. Question 2 a) Fred decided to inspect documentary evidence that all shipments made by Top Shop Ltd. have been invoiced by matching shipping documents with invoices. So he has identified all sales invoices as the population from which he intends to take a sample. Select sales invoices to inspect documentary evidence that all shipments made by Top Shop Ltd is incorrect, since all sales invoices must have shipping documents. However, have shipping documents may not issue sales invoices. Thus, Fred should not take sales invoices for the sample test. Fred should take shipping documents as sample test. b) Since Fred plans to place a high degree of reliance on this particular control, he assesses the risk of overreliance at 5%. In previous years, a 10% level was used. High percentage of risk of overreliance is more irrelevance on their clients. On the other hand, Lower percentage of risk of overreliance is more reliance on their clients. According to this case, audit manager (Mike Wong) and audit partner (Mary Lee) indicate that a higher degree of reliance is planned in the current audit, so Fred assesses the risk of overreliance at 5% which is lower than 10% level was used in previous years is correct. c) Fred assessed the expected population deviation rate at 1% in current audit year. While the rate of deviation from prior audits has approximated 2% High percentage of expected population deviation rate is worst in its processing of sales invoices. On the other hand, Lower percentage of expected population deviation rate is better in its processing of sales invoices. In this case, Top Shop Ltd. has made several improvements in its processing of sales invoices; as a result, Fred believes that a lower expected population deviation rate is appropriate. Thus, expected population deviation rate decrease from prior audit 2% to current audit 1% is correct. d) Fred uses sampling tables to calculate s sample size of 156 prior years. In current year, more than 30,000 sales invoices are processed per year, and then he increases the sample size to 175 because the population of sales invoices is extremely large. In this case, population of sales invoices is extremely large, and then increase sample size from 156 to 175 cannot have a good sample test. Since, increase 175-156=19 is relative small. On the other hand, the population of sales invoices is extremely large, continuous increase the sample size is not significance for the test. e) The sum of sample rate of deviation of 2% and allowance for sampling risk of 2.5% equal to 4.5% is less than the risk of overreliance 5% by d), Fred concluded that the control is operating effectively and decided to rely on this control as planned to reduce the scope of his substantive procedures. In this case, Fred is incorrect and risk of overreliance is irrelevant to the sample rate of deviation plus allowance for sampling risk. He should use tolerable rate of deviation to compare with the sum of sample rate of deviation and allowance for sampling risk. Thus, sample rate of deviation of 2% and allowance for sampling risk of 2.5% equal to 4.5% is more than the tolerable rate of deviation 4% by d). The control is not operating effectively and cannot rely on this control as planned to reduce the scope of his substantive procedures. Question 3 a) These third parties more likely pursue litigation against Madeoff under common law because of the auditor breach of failure to exercise reasonable skill and care. b) Case (1) First Trust Bank First Trust Bank was specifically named in the engagement letter. Prior to committing the capital, First Trust Bank had reviewed Madeoff’s financial statements and, based on the financial condition reflected in its statement of financial position, deemed Madeoff to be a qualified loan candidate. According to the case, First Trust Bank is primary beneficiaries with Allen which is known and named third parties. By law, primary beneficiaries as having this privity to contract, as a result, First Trust Bank will be treated same as client. First Trust Bank was specifically named in the engagement letter. Case (2) MoonTrust Bank MoonTrust Bank is not named in the engagement letter nor identified to Allen, Madeoff had previous business dealings with MoonTrust and maintained several accounts at MoonTrust. Based primarily on its prior relationships with Madeoff, as a result approved the financing to Madeoff prior to receiving the audited financial statements. In this case, MoonTrust Bank is foreseen beneficiaries with Allen which is known and unnamed third party. Because MoonTrust Bank is not named in the engagement letter nor identified to Allen, but based on its prior relationships with Madeoff. Case (3) Alice Lay Alice Lay request and review Madeoff’s audited financial statements and Allen’s report on those financial statements prior to providing funding. However, Alice had never entered into a loan agreement of this nature in the past. In this case, Alice Lay is foreseeable third parties with Allen which is unknown and unnamed third party. Because Alice Lay felt personal ties to Madeoff and was interested in its continued success, but never entered into a loan agreement of this nature in the past. c) Allen’s audit did not follow the HKSA but that it did not demonstrate a lack of minimum care or actual knowledge of the misstatements. Case (1) First Trust Bank According to contract law, First Trust Bank is a primary beneficiary with Allen. First Trust Bank was specifically named in the engagement letter. Besides, First Trust Bank had reviewed Madeoff’s financial statements, and then based on the financial statement deemed Madeoff to be a qualified loan candidate. Allen did not follow the HKSA, he breach of common law duties, because he failure to exercise reasonable skill and care. Besides, under contract law, Allen owed the First Trust Bank a duty of care, Allen was negligent and First Trust Bank suffered a loss as a result of the auditor’s negligence. Thus, Allen is liable to First Trust Bank. To conclude, First Trust Bank ability is to against Allen in potential claim. Case (2) MoonTrust Bank According to contract law, MoonTrust Bank is a foreseen beneficiary with Allen. MoonTrust Bank is not named in the engagement letter nor identified to Allen, however, MoonTrust Bank based on prior relationships with Madeoff, then reviewed Madeoff’s financial statements and based on the financial statement qualified the loan. Same as case (1) Allen did not follow the HKSA, he breach of common law duties and failure to exercise reasonable skill and care. Although, MoonTrust Bank is not named in the engagement letter, Allen foreseen MoonTrust Bank will be based on the financial statement and qualified the loan. Because, based on primarily on its prior relationships with Madeoff. Under contract law, Allen owed the First Trust Bank a duty of care, Allen was negligent and First Trust Bank suffered a loss as a result of the auditor’s negligence. Thus, Allen is liable to third parties of First Trust Bank. To conclude, MoonTrust Bank ability is to against Allen in potential claim. Case (3) Alice Lay Alice Lay, provided $200,000 of capital to Madeoff. While her decision was primarily motivated by Madeoff’s role in the community and its corporate citizenship, besides, she did request and review Madeoff’s audited financial statements and Allen’s report on those financial statements prior to providing funding. However, she did not entered into any loan agreement to Madeoff before. In this case, although Allen did not follow the HKSA, he breach of common law duties and failure to exercise reasonable skill and care. However, Allen can prove he did not demonstrate a lack of minimum care or actual knowledge of the misstatements, so there is no duty owed to Alice. Furthermore, they are absence of causal connection. Alice didn’t rely on the financial statement make the decission. To conclude, Alice do not have ability to against Allen in potential claim. d) The parties could prove that Allen was aware that Madeoff’s financial statements contained a material misstatement. In this case, an intentional act by one or more individuals among management, those charges with governance, employees, or third parties, involves the use of deception to obtain an unjust or illegal advantage. This is a fraud action. Relationship is irrelevant with the fraud case, when these parties prevail against Allen in a potential claim. These parties are eligible to claim the loss from Allen. To conclude, Allen is liable for these three parties potential loss. Question 4 a) Audit committees can enhance a listed company’s corporate governance. There are following eight benefits.

  1. Audit committees reviewing the financial statements on behalf of the Board, it improves the quality of financial reporting
  2. Audit committees can help risk management awareness and control which will reduce the opportunity for fraud, by create a climate of discipline.
  3. Non-executive directors sitting on the Audit Committee can contribute an independent judgment and play a positive role.
  4. Audit committees can help the finance director, and then finance director can get things done which might otherwise be difficult.
  5. Audit committees can provide a channel of communication and forum for issues of concern, so it can strengthens the position of the external auditor.
  6. Audit committees can provide a framework, when the external auditor can assert his independence in the event of a dispute with management.
  7. Audit committees can strengthen the position of the internal audit function, because it can provide high degree of independence from management.
  8. Audit committees can increase public confidence in the credibility and objectivity of financial statements and the Board.

Reference: Auditing and Assurance in Hong Kong Third Edition (Peter Tze Yiu Lau and Nelson Chi Yuen Lam) P.818 b) Good self regulation can lead to absence of major corporate failure or fraud and government will be reluctant to impose regulations on industry. However, without regulated by law, then audit committees may be inconsistency of practice and standards. Audit committees may be disproportionate significance being given to its role and may impact on corporate performance. Thus, the role of the audit committee should be left to voluntary codes of practice and should be regulated by law in all countries. Reference: The Hong Kong University of Hong Kong, ‘Auditing I study’ The Hong Kong University of Hong Kong, ‘Auditing II study unit 1-2’ Eilifsen, Aasmund., Auditing & assurance services, McGraw-Hill Education (2nd international) Peter Tze Yiu Lau, Nelson Chi Yuen Lam, Auditing and assurance in Hong Kong, Pilot Pub, (3rd edn) ACT B417 TMA1 P.1

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