Reference no: EM133417068

Auditing & Assurance Services Case Study

You are an audit senior, based in the Melbourne office, working for the chartered accounting firm of Tick & Bash (TB), which is a large national network firm with clients around Australia. You are excited to be allocated to the audit engagement team for one of TB's most prestigious clients, Smales Ltd. Smales is a publicly listed company and has been an audit client of TB for the past 15 years.

Smales is based in Albury-Wodonga, where it manufactures high-tech armour-plated personnel carriers, used by military forces. With current global geopolitics, demand for Smales' products is strong and increasing. Smales often must go through a competitive market tender process to win large government contracts. Its main product, the small but powerful Terrier, is highly specialised. Due to government regulations, Smales only does business with nations that have a recognised, democratically-elected government. Smales maintains a highly secure environment, given the sensitive and confidential nature of its vehicle designs and its clients.

Peter Harper has been the engagement partner on the Smales audit for the last five years. Peter is a specialist in the defence industry and intends to remain as review partner when the audit is rotated next year to a new partner (Elizabeth Tan, who is to be promoted to partner to enable her to sign off on the audit).

In August 2022, the CFO of Smales indicated that, as a new member of the audit team, he wanted you to able to 'hit the ground running' in the audit. Therefore, he wanted you and Elizabeth to attend a major international conference and exhibition of defence industry contractors, and would pay all airfares, accommodation, and associated expenses. The conference is held in Brisbane this year. You accept and attend, keen to develop your industry specialist knowledge. You find it a valuable learning experience.

On your return to Melbourne, you catch up with a close friend from university for dinner. You excitedly tell them about some of the interesting things you learnt at the defence industry conference, including a rumour that your new client Smales was about to be the subject of a takeover offer from a larger, US-based defence firm, Southrop Cannon Ltd. Unknown to you, your friend purchased shares in Smales Ltd based on that information.

In September 2022, Smales installed an off-the-shelf costing system to support the highly sophisticated and cost-sensitive nature of its product designs. The new system replaced a system that had been developed in-house as the old system could no longer keep up with the complex and detailed manufacturing costing process that provides tender costings. The old system also had difficulty with the company's broader reporting requirements.

Smales' information technology (IT) department, together with a team of IT consultants from TB, implemented the new manufacturing costing system, modifying the off-the-shelf system to the client specifications. Key operational staff and the internal audit team from Smales

were also significantly engaged in the selection, testing, training, and implementation stages of the new system.

The manufacturing costing system uses all of the manufacturing unit inputs to calculate and produce a database of all product costs and recommended sales prices. It also integrates with the general ledger each time there are product inventory movements such as purchases, sales, wastage and damaged stock losses.

Smales has a small internal audit department which is headed by an ex-partner of TB, Joe Minelli. Joe joined Smales after leaving TB six years ago, on completing his Chartered Accountant (CA) qualification. Joe is assisted by three junior internal auditors, all of whom are completing their Bachelor of Commerce qualification at the local university campus.

The financial report audit for the year ended 30 June 2023 went smoothly, and a clean (unmodified) audit opinion was issued.

Fast-forward to a few months after financial year-end, and the Department of Defence is now suing Smales for material overpayment on a contract for a significant number of Terriers. During the discovery process, it is found that the costing system has been incorrectly implemented, and this has resulted in a major over-valuation of inventory and hence product costs. The directors of Smales have joined TB to the legal action, alleging that the economic loss resulted from your firm's negligence in the implementation of the system and the subsequent audit of inventory.

QUESTION: Briefly Identify and explain any threats to independence for TB in the audit of Smales Ltd. Identify and explain any safeguards that may be implemented to safeguard against the threats you have identified.