Assignment 2
Value: 20%
Length: 2500 words
Question 1 – Inherent Risk, Control Risk and Audit planning (6% of total subject assessment)
You are the audit senior responsible for the audit of Delilah Ltd. You are currently planning the audit for the year ended 30 June 2012. During your initial planning meeting held with the financial controller, he told you of the following changes in the companys operations:
(i) Due to the financial controllers workload, the company has employed a treasurer. The financial controller is excited about the appointment because in the two months that the treasurer has been with the company he has realized a small profit for the company through foreign-exchange transactions in yen.
(ii) Delilah has planned to close an inefficient factory in country New South Wales before the end of 2012. It is expected that the redeployment and disposal of the factorys assets will not be completed until the end of the following year. However, the financial controller is confident that he will be able to determine reasonably accurate closure provisions.
(iii) To help achieve the budgeted sales for the year, Delilah is about to introduce bonuses for its sales staff. The bonuses will be an increasing percentage of the gross sales made, by each salesperson, above certain monthly targets.
(iv) The company is using a new general ledger software package. The financial controller is impressed with the new system, because management accounts are easily produced and allow detailed comparisons with budgets and prior-period figures across product lines and geographical areas. The conversion to the new system occurred with a minimum of fuss. As it is a popular computer package, it required only minor modifications.
(v) As part of the conversion, the position of systems administrator was created. This position is responsible for all systems maintenance, including data backups and modifications. These tasks were the responsibility of the accountant.
(vi) The managing director has returned from the USA, where he signed a contract to import a line of clothing that has become the latest fashion fad in the USA. The company has not previously been engaged in the clothing industry.
Required:
For each of the scenarios above, identify which of the components of audit risk (inherent, control or detection risk) are affected. In your answer you will need to justify you choice. Format your answer as follows:
Part Inherent Risk or CR Justification
i
ii
iii
iv
Marking criteria
Marks will be awarded for responses to question 1based on the extent to which you:
· Identify the component of audit risk affected
– Justify your selection of the relevant component of audit risk
Question 2 – Internal Controls and Substantive Testing (6% of total subject assessment)
You are the auditor of PC Ltd., a company that produces low cost electronic goods to children and young adults. The audit has a year end of 30th June 2012.
There are four main people involved with the acquisitions of inventory for PC Ltd. Ms Auburn is the purchases officer; Mr Brown is the Accounts Payable Clerk; Mr Crimson is the Financial Controller and Ms Dark is the Payments Officer.
The acquisitions system works as follows:
· Ms Auburn is responsible for purchases within PC ltd. There is a computerized inventory system and whenever the inventory level goes below a certain level, Ms Auburn prepares a purchases requisition to buy new stock from one of three suppliers that PC uses.
· Ms Auburn then prepares a three part prenumbered purchase order. Every Month Mr Crimson reviews a listing of purchase orders issued to ensure all have been accounted for. The original copy of the purchase order is sent to the vendor. The receiving department within PC is sent the second copy, which is then used as a receiving report. The third and final copy is kept on file within the purchases department along with the original purchases requisition.
· When the purchased goods arrive they are immediately sent to the receiving department where the receiving report (which is the second copy of the invoice) is filled out by the store-room employee and authorized by the store-room supervisor. A copy of this document is taken and kept in the store-room. The original is sent to Mr Brown in accounts payable.
· When the supplier invoice is received it is forwarded to Mr Brown. He checks the price on the invoice compares the quantities to the details on the receiving report and checks the footings and calculations. Once this is done he enters the details of each invoice into the computer system that updates the purchases journal and accounts payable master file.
· The invoice is then sent to Mr Crimson for authorisation. Attached to the invoice is a copy of the materials purchase requisition and the receiving report. After Mr Crimson has approved the invoice for payment the documents are sent to the person responsible for cheque preparation in the accounting department (Ms Dark).
Required:
a) Identify three controls that operate within this system and state the potential errors they are aimed at preventing.
b) Describe two additional controls (or improvements to controls) that you would implement into this system and why.
c) Describe the substantive tests that you would perform on transactions in the acquisitions cycle of this system to gain adequate assurance over the assertions of completeness, cut off and accuracy.
Marking criteria
Marks will be awarded for responses to question 2based on the extent to which you:
· Identify the relevant internal controls and the errors they are aimed at preventing.
· Describe two additional controls or improvements to the existing controls that you would implement and why.
· Describe the audit procedures you would perform in relation to the assertions identified in the question.
Question 3 – Analytical procedures and Substantive Testing (8% of total subject assessment)
Below are the financial statements and additional information for Tehran Ltd.
Balance Sheet
30/06/2012
30/06/2011
$’000
$’000
Current Assets
Cash
58
73
Receivables
4579
3928
Inventories
3624
2047
Total Current Assets
8261
6048
Non Current Assets
Property Plant & Equipment
28763
29417
Receivables
2000
2000
Total Non Current Assets
30763
31417
Total Assets
39024
37465
Current Liabilities
Bank Loan – Secured
5000
7500
Accounts Payable
2500
2473
Provisions
643
610
Total Current Liabilities
8143
10583
Non Current Liabilities
Bank Loan – Secured
22000
20000
Provisions
547
510
Total Non Current Liabilities
22547
20510
Total Liabilities
30690
31093
Net Assets
8334
6372
Shareholders Equity
Share Capital
5000
5000
Retained Profits
3334
1372
Total Shareholders Equity
8334
6372
Income Statement
30/06/2012
30/06/2011
$’000
$’000
Revenue
20007
19943
COGS
13305
15428
Gross Profit
6702
4515
Operating Expenses
3486
3047
Net Profit Before Tax
3216
1468
Tax
1254
572
Net Profit After Tax
1962
896
Retained Profits: Beginning
1372
476
Retained Profits: End
3334
1372
Tehran Ltd manufactures carpets. Approximately 80% of the companys sales arise as a result of exports. When Tehran sells abroad the customers are billed in the currency of that country.
The main raw material used by Tehran is wool, which is purchased locally in Australia. You have been informed that the companys profitability has improved due to a recent slump in wool prices.
With the exception of the managing director, Hank Largow, all of the management of Tehran are from Australia. Hank is on a five year contract which was put in place by Tehrans US parent company. Hank has a reputation for delivering results from subsidiaries which have not performed well in the past. Hank does not much like Australia and has every intention of returning to the US when his contract is finished. The US parent company was dissatisfied with the companys 2011 performance and has paid close attention to the companys performance in 2012.
The company operates a standard costing system and the finished goods inventory is valued at standard cost. Raw materials are valued at actual invoiced cost. No work in progress exists at year end. During 2012, production has been increased by 10% compared to 2011 levels. His has resulted in favourable absorption variances which have contributed to the improved profitability during 2012.
Tests on the compnays inventory and debtors controls in prior years have shown the systems to be reliable. The systems are capable of producing reports on the ageing of inventory and debtors and the sales history of individual profit lines.
Approximately 80% of the companys receivables are overseas customers and the debt is denominated in foreign currency. Most of these customers are on 60 day credit terms.
Midway through the year a new financial controller, Mr Pink, was appointed after the previous financial controller resigned. Mr Pink has informed you that a number of customers have complained about the quality of Tehran’s products.
The property plant and equipment account is broken down as follows:
Property factory building 27,000,000
Plant & Equipment (including vehicles) 1,763,000
28,763,000
Additions and disposals of fixed assets have not been substantial during 2012. The factory itself was acquired 6 years ago and since that time no independent valuation has been carried out. Hank has assured you that the current market value of the company is not less than $27,000,000.
The bank loans are secured by a fixed charge over the companys buildings. A loan repayment of $5 million due on 30th November 2012 was reduced to $500,000. Hank has stated that this was done with the agreement of the bank and that the bank is comfortable with the companys performance. Hank also pointed out that the company has made all of its interest payments on time.
The non-current receivable is an export market development grant from the federal government.
In prior years no serious differences between the auditors and the management have arisen. The audit has always been completed on time with an unqualified opinion issued.
Required:
a) Calculate the following ratios: Gross Margin, Net Profit Ratio, Return on total assets, Current Ratio, Quick Ratio, Inventory Turnover, Accounts Receivable turnover, Debt to Equity Ratio (NB, for inventory turnover and accounts receivable turnover, assume the balances for 2010 are the same as 2011).
b) Making reference to the ratios you calculated in part a) and the additional information provided, describe what you consider to be the risk factors that will impact on the audit of receivables and inventory.
c) What other risk factors (aside from those related to receivables and inventory) do you think will impact on the audit?
d) In respect to the accounts of Inventory, Accounts Receivable and Land and Buildings, outline the substantive procedures you would perform. (In your answer you will need to identify the audit assertion(s) most at risk for each of these accounts).
Rationale
This assignment has been designed to assess your ability to:
1. Understand the knowledge required by an auditor in preparing an audit strategy and audit plan.
2. Outline the types of and uses for analytical procedures.
3. Explain how the auditor undertakes an assessment of control risk and how this assessment impacts upon audit procedures.
4. Undertake substantive tests of balances and substantive tests of transactions on key cycles with reference to the financial report assertions.
Marking criteria
Marks will be awarded for responses to question 3based on the extent to which you:
· Correctly calculate all ratios
· Effectively and consistently apply the results from those ratios calculations to identify account areas at risk.
· Outline the audit procedures and related assertions used to address the risks identified in part b).