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)
