Audit Risks Controls Ethics and Independence in Health Pharma Audit

Part A

(a) One risk at the financial statement level

One significant financial statement-level risk for Health Pharma for the year ending December 31, 2023, is the potential financial impact stemming from the liquidation of Inspire Private Hospital in South Australia, a major customer of Health Pharma. As mentioned in the board meeting minutes, Inspire Private Hospital is facing liquidation due to concerns over its operational practices and misuse of painkillers, and Health Pharma is associated with the hospital.

(b) Key risks of material misstatement

Risk 1 - Revenue Recognition: There is a risk that revenue from the troubled Inspire Private Hospital may not be fully recognized, or there may be uncertainties regarding the timing and collectability of this revenue due to the hospital's financial difficulties. Completeness of revenue recognition is a concern here.

Risk 2 - Impairment of Customer Contracts : The potential liquidation of Inspire Private Hospital, a significant customer, could lead to the impairment of customer contracts recognized as intangible assets. The valuation and impairment assertions regarding these assets need to be carefully assessed.

Risk 3 - Share Option Plan : Health Pharma's plan to issue share options to the CEO and CFO introduces a risk related to the existence and valuation of these share options. It's crucial to ensure that they are accounted for correctly and that their valuation aligns with accounting standards.

Risk 4 - Adequate Disclosures : With significant developments such as the potential financial impact of the Inspire Private Hospital situation and the introduction of the share option plan, there's a risk that the financial statements may not provide adequate disclosures regarding these matters. Presentation and disclosure assertions need to be assessed to ensure transparency and compliance with accounting standards.

(c) Two potential changes required

Increase in Overall Materiality : If the potential financial impact from the liquidation of Inspire Private Hospital is deemed to be significant, it may warrant an increase in the preliminary overall materiality to ensure that the audit scope adequately addresses this risk. An increase in materiality would mean that smaller misstatements are considered immaterial and can help focus audit efforts on more significant areas.

Additional Consideration for Share Option Plan: The introduction of the share option plan for the CEO and CFO, though scheduled for recognition in 2025, should be considered in the overall materiality assessment. Any immediate expenses or disclosures related to this plan should be evaluated to determine if they impact materiality. This might result in adjustments to the preliminary overall materiality calculation.

Part B

(a) For control R1:

1. The design of this control is not effective. The control's original intent was for all manual journals to be reviewed by the Finance Manager and electronically signed off. However, Rosie, the Finance Manager, did not review one of the manual journals, indicating a design flaw in the control. The compensating control implemented by Rosie, which involves preparing monthly management reports, while helpful, does not fully compensate for the deficiency in the original control design.
2. The implementation of this control is also not effective. Rosie did not follow the control's intended process and did not electronically sign off on a manual journal. This suggests a failure in the execution of the control as designed.

• The audit junior, Jason, concluded that there were no issues due to the compensating control. This conclusion is not accurate. While the compensating control might mitigate some risk, it does not entirely address the issue that the original control was designed to manage. The absence of Rosie's review and electronic sign-off is a deficiency in control that needs to be acknowledged.

1. Control Risk: Given the design and implementation deficiencies of the control, control risk for management override of controls is relatively high.

Appropriate Audit Approach: Given the higher control risk, the auditor should take a more substantive approach to test for the risk of management override of controls.

1. A practical recommendation for improvement is all manual journals should be submitted to the Finance Manager and only after the Finance Manager's approval, the journals can be posted.Top of Form

(b)

In the situation described for Control P1, the key ethical fundamental principle at risk is Integritybecause of the failure to accurately document audit procedures, concerns related to data integrity and confidentiality, and planned delays in updating work papers. Maintaining integrity is crucial in audit work to ensure that the results are credible, reliable, and trustworthy.

(c)

1. The IT team reported that they did not identify any exceptions during their testing of these controls. This is a positive result, indicating that the manage change process, which involves making changes to the purchase-to-pay software, is functioning effectively from an IT control perspective. This supports the effective functioning of application controls since a well-controlled change process reduces the risk of unauthorized changes affecting application functionality.

ii.Impact on the proposed audit approach

The positive results from the GITC testing reduce the IT-related risk assessment for the purchase-to-pay software. This means that the auditor can place greater reliance on IT controls when planning the audit. With effective GITCs in place, the audit approach may focus more on substantive testing to ensure that application controls are effectively preventing or detecting errors and fraud. This could include testing the actual transactions processed by the software and reconciling data with source documents. The effectiveness of GITCs may impact the auditor's decision regarding the sample size for substantive testing.

(d)

Mandy's request to join the Health Pharma audit team raises significant ethical and independence concerns due to her spouse's ownership of shares in Health Pharma. Her participation in the audit could potentially compromise the independence and objectivity of the audit team, which are fundamental principles in the auditing profession. It would not be appropriate for Mandy to join the Health Pharma audit team. To maintain the integrity of the audit process and adhere to professional and regulatory standards, auditors must ensure that there are no conflicts of interest or independence issues that could compromise the audit's credibility. Mandy's participation in the audit engagement could potentially violate these critical principles.

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