FAR EASTERN UNIVERSITY

INSTITUTE OF ACCOUNTS BUSINESS AND FINANCE

ACT1202 – Auditing and Assurance Principles

Case Study No. 1 Answer Sheet

Name: Donise Ronadel D. Santos Section: 3

Student No.: 2018046441 Grade:

1. What are the procedures that an auditor performs before accepting a client or continuing an
engagement?
Before accepting a client or continuing an engagement, an auditor must perform three client
acceptance and continuance procedure. First is considering the client’s integrity by reviewing the
client documents such as financial statements, annual reports and income tax returns; inquiries with
third parties such as bankers, legal advisers, investment banker and business community;
communicate with previous auditor; and consider other circumstances or sources of information.
For the second procedure, it is to evaluate the competence of the auditor to perform audit
engagement, availability of time and resources. For last procedure, it is the compliance with ethical
requirements especially independence.
2. Using the company’s financial information, calculate relevant ratios to obtain a better
understanding of the prospective client and to determine how the company is doing financially.
Compare the company’s ratio to the industry ratios and identify any significant differences.

Industry Ratio Industry Ratio Company Ratio Company Ratio

(2020) (2019) (2020) (2019)
ROE 20% 18% 14.59% 13.74%
ROA 15% 16% 9.95% 11.09%
Receivable Turnover 4.3 5.2 4.26 2.08
Ave. Collection period 83.72 69.23 84.51 173.08
Debt Ratio 0.3 0.25 0.32 0.19
Current Ratio 1.15 2.11 2.09 4.37
Profit Margin 10.60% 12.40% 4.39% 7.31%

In comparison of company’s ratios and industry’s ratios shown above, it can conclude
that the return on equity (ROE), return of assets (ROA) and receivable turnover of the company's
ratio is lower than the industry ratio which means that Central Energy Corporation’s assets are
not being managed effectively which resulted to a lower profit. Moreover, the average
collection period of the company shows that that the company can only collect the receivables
longer than expected or it has a probability that they can no longer collect their receivables
which is not good for the company. However, for the current ratio, it shows that the company
has the ability to pay its current liabilities as they mature which is a good thing for the company.
Overall, nevertheless, the company’s profit and liquidation heavily depends on company’s
performances and results of their ratios.

3. What other information should be considered before accepting CEC as a client? How important
are these issues to the client acceptance decisions and why?
Before accepting CEC as a client, other sources of information such as communication with
existing and previous providers of professional accountancy services to the prospective client,
inquiry of other firm personnel or third parties such as bankers, legal counsels and industry peers,
and background searches of relevant databases should be considered.
 FAR EASTERN UNIVERSITY
INSTITUTE OF ACCOUNTS BUSINESS AND FINANCE
ACT1202 – Auditing and Assurance Principles

Case Study No. 1 Answer Sheet

Those other information mentioned above are important because decisions and opinions of
an auditor lies on those information. It can help an auditor to obtain such information needed to
determine the client’s integrity and support the auditor’s judgement as to whether he would accept
the client or not.

4. The prospective client also indicated its interest in obtaining tax services from the firm. What
are the pros and cons of providing this service to the company?
One of the cons when an auditor provides an audit and tax services at the same time to a
client is that in can result to a collusion between the client and the practitioner. Moreover, it will
have fewer aggressive tax positions.

5. It was noted that a partner of the firm has an investment in a fund that has an equity to the
potential client. Would this situation constitute a violation of independence in accordance to
Code of Ethics for Professional Accountants in the Philippines?
No, because according to the Code of Ethics for Professional Accountants, it depends on
the role of the person holding the financial interest, whether it is direct or indirect, and its
materiality. Since the partner’s interest was less than 1% of the company’s entire capitalization,
it violates nothing and has no influence decision and controlling interest with CEC.

6. Prepare a memo to the partner making a recommendation as to whether the firm should or
should not accept Central Energy Corporation as an audit client. Justify your position in light of
the information in the case.

MEMORANDUM

September 15, 2020

To: EARL C. SANTOS

From: DONISE RONADEL D. SANTOS

Junior Manager

SUBJECT: DECISION AS TO WHETHER CENTRAL ENERGY CORPORATION SHOULD BE ACCEPTED OR NOT

Based on the performance of the pre-engagement activities for accepting a client, I observed and
noticed that we should not accept CEC as an audit client. The following are the reasons why we should
not accept the audit engagement with the company CEC:
1. The Chief Executive officer of CEC, Sean Baker, uses recreational drugs which is illegal in our
jurisdiction and will indeed affect our company’s reputation. Associating ourselves with him will
only put our company in danger.
2. According to our independence reviews, self-interest may occur if they will be accepted because
my nephew is having his internship in the engineering department of CEC.
 FAR EASTERN UNIVERSITY
INSTITUTE OF ACCOUNTS BUSINESS AND FINANCE
ACT1202 – Auditing and Assurance Principles

Case Study No. 1 Answer Sheet

3. Lastly, it was seen in their background that they have done a tax evasion and was subjected to
audit by the BIR. They have a history over declaring their expenses to lower their taxable profits.
Thus, it may affect our company’s reputation.

A separate memo will be released for the list of issues and risks.

I look forward to your support in this matter.

Thank you.

7. Prepare a separate memo to the partner briefly listing and discussing three to five most
important issues or risk areas that will likely affect how the audit is conducted if the prospective
client is accepted and how the firm can address such issues.

MEMORANDUM

September 15, 2020

To: EARL C. SANTOS

From: DONISE RONADEL D. SANTOS

Junior Manager

SUBJECT: ISSUES THAT WILL AFFECT THE AUDIT ENGAGEMENT FOR CENTRAL ENERGY CORPORATION

To support my claims on my latter memo, I would like to inform you about the findings I have obtained.
The following are the risk that will likely affect our audit if we accept the said client; followed by the
recommended course of action:

1. There is a high probability of inherent risk because of the complexity of the entity’s nature
of business and transactions. On the other hand, with the help of computerized accounting
system, the probability of control risk is low because it lessens the prone to human errors.
As recommendation, it is better to use an audit risk model and perform more audit
procedures to lessen the detection risk.
2. Since CEC is unfamiliar with our industry, their auditors would not be able to detect
misstatements and other issues immediately which may result in an increased detection
risk. However, as my recommendation, in spite of unfamiliarity and lack of knowledge in one
company’s background, history of engagements with other type of industry in the energy
sector can be used and it will be helpful if we will accept CEC.
3. We only have few months left to complete and conduct the audit. Thus, we might not be
able to finish all appropriate audit procedures. However, if we will hire more professionals
and experts that will help our audit team and are more knowledgeable with the renewable
energy sector, it is possible to finish it.
 FAR EASTERN UNIVERSITY
INSTITUTE OF ACCOUNTS BUSINESS AND FINANCE
ACT1202 – Auditing and Assurance Principles

Case Study No. 1 Answer Sheet

I look forward to your support in this matter.

Thank you.