- Explain the process of audit planning to determine risk assessments and an overall audit strategy.
- Explain the auditors’ obligations with regards to understanding the client’s business and internal controls and assessing business risks.
- Achieve a high level of competence in applying prescribed auditing techniques in gathering evidence to satisfy audit assertions
Your task is to answer a selection of tutorial questions for weeks 7 to 11 inclusive and give these answers.
The questions to be answered are;
Mermaid Beach Hotel Ltd (Mermaid Hotel) operates a seaside hotel on the Sunshine Coast, providing accommodation, bar and restaurant facilities for tourists. Casual and part-time wages are a major expense item, particularly during summer, when up to an additional 30 staff members are employed. In order to keep track of casual and part-time wages, Mermaid Hotel’s operations manager prepares a weekly roster (using Excel) showing:
- employment position (e.g. bar staff)
- days and hours rostered for the week
- any additional amounts to be paid (e.g. meal allowances).
Each employee’s immediate supervisor is required to sign a hard copy of the Excel roster spreadsheet on a daily basis as evidence that the hours were worked as rostered. Any discrepancies (e.g. additional hours) are recorded on a separate payroll adjustment form (PAF) and co-signed by the employee. The Excel roster spreadsheet plus any PAFs are forwarded to the payroll officer at the end of the week and used as the basis for that week’s casual and part-time employee payroll. Last year, you still placed reliance on controls over casual and part-time wages, despite finding some breakdowns in controls, as you were able to obtain sufficient appropriate audit evidence that the controls were operating effectively. Assume that you have decided it is appropriate to test internal controls over the relevant payroll transactions.
Briefly outline how the information provided above would affect the nature, timing and extent of tests of controls.
You are the audit manager at Price & Coopers a medium-sized audit firm undertaking the audit for the year ended 30 June 2018 of Sera Ve Tech Ltd, an electronic component manufacturer located in Sydney. During the planning stage of the audit you discovered that one of Sera Ve Tech Ltd’s major suppliers went bankrupt one month ago, causing major product shortages. To overcome the problem, James Marshall, the husband of the finance director, Norita James, provided electronic components to Sera Ve Tech Ltd through his private company. There is no formal agreement in place with James Marshall, however, the goods are being provided at competitive prices. You are concerned about the electronic components that James Marshall, company is supplying, because his products are new to the market and you have heard some of Sera Ve Tech Ltd’s staff complaining that they are of poor quality.
The board has informed you that although sales have been strong this year, Sera Ve Tech Ltd has suffered significant cash flow problems because a major debtor, Merrinda Ltd, is experiencing financial difficulties. As a result, Merrinda Ltd is taking well over 120 days to pay outstanding amounts, despite Merrinda Ltd’s terms of trade being payment within 30 days. Merrinda Ltd makes up 40 per cent of Sera Ve Tech Ltd’s sales and the board has been reluctant to take any action that might adversely affect those sales. As a result, Sera Ve Tech Ltd has had to increase its dependency on its line of credit, and this has caused it to temporarily breach the debt to equity ratio required in its loan covenant with Commonwealth Bank Ltd.
(a) Identify two (2) key account balances at risk of material misstatement.
(b) For each account balance identify the key assertion at risk.
(c) Explain why the account balance and assertion are at risk.
(d) Describe one (1) substantive test of detail that you would undertake for each account to address the assertion and risk identified.
Axel Heckman is the engagement partner for the financial report audit of Sturfolks Equipment Ltd for the year ended 30 June 2018. The following material events or transactions have come to Axel’s attention before he is scheduled to issue his report on 31 August 2018:
(a) On 14 July 2018, Sturfolks Equipment settled and paid a personal injury claim of a former employee as a result of an accident that occurred in March 2017. The company has not previously recorded a liability for the claim.
(b) On 17 July 2018, Sturfolks Equipment agreed to purchase for cash the outstanding shares of Recreational Equipment Ltd. This acquisition is likely to double the sales volume of Sturfolks Equipment.
(c) On 20 July 2018, the directors became aware of broken glass found in their pre-packaged sandpits. This product had only been on sale for two weeks and had been purchased directly from the manufacturer, NSWPIT Ltd, an unrelated company in Thailand, one week prior to being introduced to the public.
(d) On 3 August 2018, a plant owned by Sturfolks Equipment was damaged in a flood, resulting in an uninsured loss of inventory.
For each of the above events or transactions, identify audit procedures that should have brought the item to the auditor’s attention, and determine the treatment required in the financial report for the year ended 30 June 2018.
What are key audit matters? How do these affect the format of the audit report?
Explain the effect of the misstatement on the auditor’s report and the audit opinion in each scenario stated below:
(i) You have completed the audit of Saibal Resort Ltd (Saibal Resort) for the year ended 30 June 2015. The audit partner suggested that the value of properties on the West Coast were overstated by $16 million, a figure which was twice the level of materiality set for the audit. As a result of discussions with the audit committee, the CEO of Saibal Resort agreed to revise the valuations downward by $10 million. All other issues were resolved to the satisfaction of the audit partner, resulting in an overall misstatement of the financial report of $6 million.
The audit partner is now considering the effect of the misstatement on the auditor’s report.
(ii) Jason King Ltd is a building contractor with a varying workload. In order to compensate for the irregularity of its contracted building projects, Jason King also purchases large vacant blocks of land that it later subdivides for the construction of houses and units. Jason King then sells these on its own account. Your analysis strongly suggests that the apportionment of costs to houses and units sold has been kept low to boost profits. In your opinion, this has resulted in the overvaluation of the unsold properties. The directors of the company do not agree and hold to their view that the stock of properties is correctly valued.
The following information relating to Tedy Brown’s operations has been identified:
Tedy Brown has an accounts receivable insurance policy that allows the company to claim for bad debts of up to $50 000 per annum. The amount covered under the policy has remained the same since 2012 (when the accounts receivable balance averaged $2 000 000). Since 2012, the average accounts receivable balance has increased to $3 800 000.
Tedy Brown sales representatives are entitled to commission on sales above quarterly targets. Any commission earned is required to be paid in the month following the quarter. In the year ended 30 June 2015, on two occasions, the commissions were paid three months following the quarter.
There were numerous occasions during the year where major debtors, representing 40 per cent of gross revenues, settled their accounts 45 days after the due date. These debtors have been long-standing and reliable customers.
Tedy Brown does not enter into foreign exchange contracts to fix its exposure to foreign currency movements, as it has never previously suffered significant foreign currency losses. During the year ended 30 June 2015, Tedy Brown incurred foreign exchange losses representing 10 per cent of net profit before income tax.
(a) Identify which two (2) items are primarily relevant only to the head of internal audit. Justify your answer.
(b) Identify which two (2) items are significant and direct concerns for both the external auditor and the head of internal audit. Justify your answer.