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MAA303 Audit and Assurance

Question

Answered

Task

Case Data: Morris Ltd

You are the audit manager planning for an audit of your client Morris Ltd (Morris).  Morris has been recently listed on the Australian Securities Exchange (ASX). Morris sells herbal medicines to customers based in Australia, New Zealand and has plans to expand to USA, Canada as well as to the smaller Pacific markets. The sales channel includes in-store sales, on line and direct to wholesalers.

The herbal medicines are manufactured by a pharmaceutical company based in Malaysia under an agreement with the manufacturer.  The company’s key product is a root-based product grown in the South Pacific countries and is aimed at reducing anxiety levels for individuals who suffer from the condition.

Currently, the company has 90 capsules per bottle product, but the CEO informs you that the company aims to have 60, 30 and 20 capsules per bottle products in the future.  The company is also investigating the use of different varieties of this root and their effect on anxiety level for future development.

Morris expects that the demand for the products will increase over time so during the year Morris made the following key appointments:

  • Fran Walker as Chief Marketing Officer who has over 20 years’ experience in the consumer sector.
  • Michael Lee as General Manager of sales (International Markets).

To cope with the expected increase in demand a new web-based system was implemented for online sales.  The accounting information system was also changed to cope with the different sales channels.  The Information technology manager told you that “as usually is the case when companies change their IT systems, we also had some initial teething problems, but they seem to have been ironed out as I haven’t heard anyone complaining about it recently”.

Reading the minutes of a recent board meeting, you discover that the board has indicated its strong intention to raise additional capital to fund ongoing operations together with its initiatives to drive revenue with new product in new market segments in 2020. Some of the funds would also be used to reduce the debt level. The board minutes also indicate that a customer is taking legal action against Morris because she claims to have suffered severe adverse reactions after taking the capsules. No provision for has been made for any penalties that Morris may have to pay.

As part of your planning you have made enquiries of management and other personnel. From your enquiries you have gathered the following additional information:

  • The loan was obtained from Bank of Burwood. There is a loan covenant requiring Morris to maintain a current ratio greater than 1.3.
  • Some of the inventory was sent by the Manufacturer was shipped FOB meaning that the ownership of the goods was transferred to Morris when the goods were loaded in Malaysia.  However, it appears that the goods may have been damaged, and the shipping company is still investigating the case. These goods worth AUD 200,000 is included in the balance sheet.
  • Morris pays the manufacturer in Malaysian currency (Malaysian Ringgit).
  • During the financial year, a bonus scheme was introduced for senior managers. To increase sales revenue, this bonus is based on a percentage of gross profit.
  • Recent tropical cyclones in the South Pacific countries that supply the raw materials has damaged the plantations from which the medicines are derived. This increased the price of raw materials and it is expected that the manufacturer will pass this increase on to the client.
  • Due to the size of the board, the company does not have a separate audit committee. You have been informed that the full board carries out the duties that would normally be assigned to the audit committee.  

Morris Ltd

Income Statement for Year Ended 31 December 2019

 

2019

(Draft)

2018 (Audited)

 

‘000

'000

Revenue

 

 

Sales Revenue

18,325

6,351

Cost of Goods Sold

14,811

4,853

Gross Profit

3,514

1,498

Other Income

26

332

Less: Expenses

 

 

Shipping

1,866

1,078

Employee Benefit

2,974

2,563

Share Based Payments

52

1,601

Depreciation & Amortisation

692

217

Selling & Marketing

1,500

964

General & Admin

1,183

1,224

Other Expenses

1,537

1,135

Total Expenses

(9,804)

(8,782)

Operating Loss

(6,264)

(6,952)

Less: Finance Cost

(923)

(207)

Loss Before Income Tax

(7,187)

(7,159)

Less: Income tax Expense

-

-

Loss After Income tax

(7,187)

(7,159)

Morris Ltd

Statement of Financial Position as at 31 December 2019

 

2019

(Draft)

2018

(audited)

 

'000

'000

Assets

 

 

Current assets

 

 

Cash and cash equivalents

2,376

5,166

Trade receivables

1,697

787

Inventories

2,067

780

Other

646

341

Total current assets

6,786

7,074

Non-current assets

 

 

Plant & Equipment

10,604

2,058

Intangibles

1,729

1,530

Total non-current assets

12,333

3,588

Total Assets

19,119

10,662

Liabilities

 

 

Current liabilities

 

 

Trade Payables

3,464

1,772

Loans

1,144

73

Employee benefits

273

66

Total current liabilities

4,881

1,911

Non-current liabilities

 

 

Loans

7,816

2,269

Other non-current liabilities

1,982

2,196

Total non-current liabilities

9,798

4,465

Total Liabilities

14,679

6,376

Net Assets

4,440

4,286

Equity

 

 

Issued capital

63,200

57,352

Reserves

15,551

14,058

Accumulated losses

(74,311)

(67,124)

Total Equity

4,440

4,286

 

 

 

Number of shares outstanding

1,000,000

900,000

Required

1. ASA 315 (para. 6) identifies analytical procedures, enquiries of management and others and observation & inspection as the procedures to use during risk identification process.

Explain why analytical procedures are used during risk assessment process. (3 Marks)

2. As stated in question 1, auditors would make enquiries of management as per ASA 315 (para 6).   

Explain what professional skepticism is and why professional skepticism is important during the planning of the audit. (3 Marks)

3. Preliminary assessment of materiality helps the auditor to plan the audit and to carry out the audit testing.

Based on your understanding of the entity from the information provided above, calculate the overall planning materiality. Justify the choice of the appropriate base and the materiality amount. (3 Marks)

Rules of thumb for planning materiality:

Base

Ranges of percentages applied to base

Profit before tax

5 - 10%

Total Revenue

0.5 – 1%

Total Assets

0.5 – 1%

Equity

1 - 2%

 
4. Carry out the analytical procedures by calculating the ratios based on the information provided in the financial statements provided. (4 marks)
 
5. Based on your analytical review of the company (in question 4) and the other information provided, identify areas that would require further attention during the audit and comment on the going concern ability of the business. (7 Marks)
 
(Total 20 marks)

MAA303 Audit and Assurance

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