Audit Risk and Financial Report Considerations

Question 1

Consider the following independent situations, all of which apply to audits of entities for the year ending 31 December 20X7:

(i) Slipway Limited, a listed company, has been experiencing declining sales over the last 2 years. Cost cutting has proved difficult due to the high level of imported machinery used in Slipway’s operations and consequently margins have been falling. While the bankers are presently happy to continue providing Slipway with loan facilities, they do expect to see improved results in the next financial report. Articles about Slipway’s expected financial results appearing in recent press reports all had quite a pessimistic tone.

(ii) Discount Foods Limited is a large supermarket chain with offices in all capital cities around Australia. Until 30 June 20X7 data processing relating to payroll transactions will be carried out in each capital city by an independent computer service bureau.

(iii) Getaway Pty. Limited is a long-established firm which has been operating a boutique hotel in the Blue Mountains for over 20 years. During this time, it has adopted a conservative business strategy that has seen it produce adequate, though slightly unimpressive, results. A new CEO has been appointed to run the firm from 1 September 20X7. He has already released his plans for renovating the hotel, despite not officially serving as CEO yet. You have also heard him discuss the implementation of a new marketing strategy to boost occupancy rates.

(iv) Angora Pty. Limited is a small primary producer specializing in the production of angora wool. Angora’s recent display at a trade show has seen orders flood in from overseas buyers. The accountant, Michael, has done his best to satisfy the orders as quickly as possible while maintaining the appropriate (foreign currency) accounting records. However, from some of the questions he has been asking you, you suspect he is out of his depth.

(v) Kings Pty. Limited has been manufacturing uniforms for the Australian market for the last 40 years. The government’s recent tariff reduction policy has placed Kings in direct competition with cheaper uniforms manufactured overseas. In a bid to retain market share, Kings has been selling part of its school uniform range at less than cost. However, overall profit figures remain buoyant.

Required:

For each of the above independent situations describe the overall impact on audit risk and identify the specific component(s) of audit risk affected

Question 2

Eagle Sawmill Limited (Eagle) operates a timber sawmill in a large regional town. It sources its raw material (pine logs) from a number of local growers and from its own plantations. Logs are transported on large trucks that are weighed in on the company’s weighbridge and weighed out after dropping their loads in the storage area. Logs are then debarked and sawn to size in the cutting area of the mill. The various logs are then sent to other areas of the sawmill depending on what they will be used for.

You are a senior on the audit. During the planning stage of the audit, you perform analytical procedures. In the current audit period, the average number of days to pay creditors has declined significantly from the average recorded over the past three financial years.

Your investigation reveals that log suppliers represent more than 90 percent of the value of accounts payable. As an internal control, details of the goods received notes are matched against the supplier’s invoice. The accuracy of the invoice is checked, after which the invoice is authorised for payment by the mill accountant. Any discrepancy between what the supplier’s invoice amounts should be and the actual amount charged by the supplier is communicated to the supplier by way of a pre-numbered ‘request for credit’ form. This form provides reasons for the differences and the amount requested to be credited to the company by the supplier.

The correct amount of the invoice is entered into the accounts payable accounting system and the supplier’s monthly statement is reconciled to the accounts payable balance per the creditors’ ledger at month end. The differences are mostly attributable to:

a. Unprocessed invoices due to pricing differences

b. Timing differences in the recorded date of a payment made

c. Amounts requested for credit

d. Settlement discounts disallowed.

Lee Hayward, the company’s financial controller, informs you that due to the increase in the price of timber, new contracts with suppliers have been negotiated over the past year. The accounts payable personnel have complained that management is too slow in informing them about the effective dates of the implementation of the contracts and the revised prices. A brief inspection of the accounts payable reconciliations for five of the biggest suppliers indicates that many invoices are being held back due to the lack of correct pricing.

Required

a) List two key assertions at risk in relation to accounts payable;

b) Provide your justification for each assertion.

c) For each assertion, outline two substantive tests of details to obtain sufficient appropriate audit evidence

Question 3

Consider each of the following independent and material situations. In each case:

· the financial report date is 31 December 2019;

· the field work was completed on 12 February 2020;

· the directors declaration and the audit report were signed on 19 February 2020; and

· the completed financial report accompanied by the signed audit report were mailed to shareholders on 18 March 2020

A. You are an auditor pf AB Limited (AB), a company specialising in industrial property development. On 10th January 2019, AB purchased property and entered into a contract to develop a shopping complex and then sell the developed real estate to an unrelated third party for a ‘cost-plus’ settlement price. Following the sale on 20th October 2019, an economic recession resulted in the rentals and occupancy rates being well below forecasts prepared by your client. On 10th January 2020, the purchaser threatened to sue for damages, alleging they relied on your client AB’s forecasts when entering into the contract. The amount of damages being claimed is highly material to your client. You have obtained an opinion from a well-known Senior Counsel (SC) who concludes that damages are likely to be payable.

B. You are the auditor of Australian Paper Limited (APL). A division of APL prints and publishes books about celebrities. A large print run of a scandal packed book titled ‘The Secret Life of Brickley Cooper’ was produced in January 2020. As of 31st December 2019, stocks of raw materials were around one-third higher than usual, as the division purchased extra materials in order to produce this book. On 20th March 2020, Brickley Cooper was killed in tragic circumstances while rescuing a young child from a burning house. APL pulped the book on 25th March 2020, after receiving advice that selling the book following Brickley Cooper’s tragic and heroic death would result in a severe public backlash

C. You are the auditor of GISCO Limited (GISCO), a professional services client. On 5th February 2020, GISCO settled and paid a personal injury claim to a former employee as a result of an accident that occurred in December 2016. GISCO had not previously recorded a liability for the claim.

D. You are an auditor of JK limited (JK), a major public company involved in the property development industry. Prior to signing your audit report, you sought a letter of comfort from JK’s bankers that the bank would continue to support JK by providing finance over the coming year. The bank agrees that it would continue to provide finance. It was your view that without such support JK had severe cash flow problems and the financial report would need to be modified with respect to a going concern assumption. On 10th March 2020, the company’s bankers wrote to you advising that the company had breached its loan covenant with the bank in February 2020 and that the loan facility was now due and payable and would not be renewed.

E. You are the auditor of Absolute Wonder Limited (AWL). AWL holds investments in several companies listed on the Hong Kong stock exchange. On 10th February 2020, the exchange’s value plummets by 30 per cent.

Required

For each of the events A to E:

1. Outline the required treatment in the financial report, if any. Justify your answer. 2. Determine whether additional audit evidence needs to be obtained. If so, describe the nature of the audit evidence to be obtained and the audit procedures used to obtain it. 3. If no action is taken by management, determine the most appropriate audit opinion to be issued.

Question 4

You are currently auditing Speed Pty Ltd (Speed), a subsidiary of Tech Ltd (Tech). Speed is an internet service provider that provides free internet access to its subscribers. In return, subscribers agree to provide their name, address and other details to Speed for the purpose of on-selling this information to various marketing firms. When Speed was established two years ago, its business plan stated that it would need 25,000 subscribers in order to break even. Speed has experienced demand far in excess of this but unfortunately, due to technological problems, it can only provide services to 21,000 subscribers at the present time. This has reduced the price that third parties are prepared to pay for subscriber information, as they need a certain volume of each type of consumer (for example, males aged 25-35 earning more than $60,000 p.a.) to make their marketing efforts worthwhile. Speed is the third largest of seven ‘free-access’ providers in the industry. The two biggest providers are each approximately 30 percent larger than Speed, and both are seeking to rapidly expand their customer base. Over the past few months, Speed has been negotiating to buy the business of one of its smaller rivals, Network Pty Ltd (Network). This would give Speed access to more subscribers and, more critically, access to Network’s software, which has the capacity to support another 50,000 users

In response to Speed’s directors’ concerns regarding Speed’s financial situation, Tech has agreed to become a ‘lender of last resort’ should Speed need urgent financial assistance. However, Tech’s management has made it clear that this assistance will only be provided if Speed is in serious danger of going into receivership.

Speed’s directors are all young ‘whiz-kids’ with backgrounds in the computer and technology industries. Each has an equity share in the business. Recently the board split into two distinct factions, and relations among the board members are now less than harmonious. The financial controller has expressed concern that key business decisions are being delayed because the board is not focused on the business. Unresolved issues include a proposed additional capital injection from each of Speed’s directors to see the company through its present difficulties

Required:

a) List the factors that indicate that Speed may have a going concern problem. For each factor, identify and discuss any related mitigating factors. 

b) Outline the key additional information you would need to obtain before reaching a conclusion on Speed’s going concern status.

c) If all seven entities in the industry are experiencing software problems and are unable to satisfy demand for their services, how will this change the way you assess the going concern status of Speed