Auditing - Assignment
You are the audit senior of the accounting firm ELC Ltd, currently planning the 2011 audit of RMS Limited, a wholesaler of sporting goods. RMS carries a wide range of goods (approximately 200 items), which it purchases from half a dozen suppliers. The majority of sales are made to major chain stores and large independent retailers, as well as government bodies such as schools.
There is significant pressure on fees, and the audit partner is concerned that the audit be carried out in an efficient manner. Detailed discussions with the client and a review of last year's audit files have revealed the following information:
1. Sales are of two types: 'Sale or return' (SOR) and normal sales. Details on each type of sale are as follows:
SOR sales were introduced in the late 1990s to combat the effects of the recession on selected new product launches. Customers are able to purchase new products on credit and hold them for up to three months without paying for them (unless they are sold). Customers may return the stock in good condition for a full credit at any time within the three month period. Typically SOR sales are only available to customers for new products in the first two months of the product launch. After this period, sales are made under normal conditions.
Customers must provide RMS Limited with a monthly SOR stock report, which details the units of each product on hand at the beginning of the month, reconciled to the units on hand at the end of the month. This enables staff at RMS Limited to keep track of SOR stock balances.
A year end provision/allowance for return of SOR sales is made by RMS Ltd. This is based on the average return percentages experienced in the 12 months prior to RMS's June 30 balance date. The return percentage is calculated as SOR sales returns divided by SOR sales. The average percentage expected to be used for the year 2011 is 5 percent. Normal sales are made under generally accepted trading terms of 30 days.
2. TT Limited, the supplier of unique teflofibre sweatsuits, is in financial difficulties and may lose the license to distribute the product in Australia. Management is aware that another sporting goods wholesaler is considering purchasing the license in order to gain the exclusive rights to sell the sweatsuits.
A current trading agreement allows RMS Limited to purchase TT Limited's entire stock of the sweatsuits, which due to limited supply are rationed amongst customers. At present about 70 percent of customers are able to purchase the sweatsuits. Sweatsuits currently comprise about 6 percent of annual sales.
3. Around 50 percent of sales are made to government bodies which, despite being slow payers, are a good source of income. Sales tend to receive a boost in around June.
4. A new product, W Strap, was introduced in December 2010 to take advantage of the Christmas sales period. The strap is a new form of sweatband, and constitutes 2 percent of total sales. Due to its proven success in the US market, sales of W Strap were made under normal terms and conditions.
You are aware from newspaper articles that several people have suffered wrist injuries as a result of the strap tightening without warning whilst in use. From discussions with the Product Manager, you find that the reason for the fault is the use of the wrong type of rubber in the manufacture of the strap. However it is not yet clear how many of the straps are affected by this fault. Only two major chain stores have purchased this product to date.
5. A new product, Racquet X, was introduced on an SOR basis in October 2010. An average of 37 percent of all Racquet X stock sold has been returned by customers over the last 12 months. Sales of Racquet X represent approximately 6.5 percent of the year's total sales.
6. During the financial year ending on 30 June 2011, another wholesaler joined the market and aggressively marketed its products so that some of RMS's customers switched to the new competitor. In an effort to encourage its sales staff to gain new customers, RMS introduced a "sales bonus" payment for sales staff and store managers based on two performance measures: the number of new customers and total store sales. As a result, RMS has gained about 30 new customers, the majority of which are small retailers.
7. Allowance for doubtful debts is usually calculated by the client company as 2% of sales revenue. RMS is using the same percentage for the 2011 year. As RMS's CEO believes store managers have better local knowledge, store managers are responsible for making decisions such as giving customers credit and writing off bad debts.
8. Financial data extracted from the February 2011 management accounts is as follows:
Selected financial data for the 8 months to 28 February 2011
$'000
SOR sales 1,850
Normal Sales 5,110
Less: allowance for return of SOR items -553
Total sales 6,407
Operating profit before tax 853
Debtors/Accounts receivable 2,627
Total assets 7,100
Total liabilities 4,473
The audit partner for the RMS audit has decided that a fully substantive approach is to be adopted, as this is considered to be more efficient.
Required - You have been asked by the audit manager to perform work on the sales/debtors cycle. This involves the following transaction class/account balance.
(1) Sales
(2) Allowance for sales returns
(3) Debtors
(4) Allowance for doubtful debts
1. For each of the above transaction class/account balance, you are required to:
(a) Identify and briefly explain the key audit objectives.
(b) Detail the audit procedures that the audit team should perform in order to accumulate sufficient appropriate audit evidence for the audit objectives identified in requirement (a). Where applicable, explain the reasons for your choice of audit procedures/techniques, areas that require special attention and the extent of audit testing required (e.g., relative to previous years).
2. Auditors have a responsibility to assess the going concern status of the audit client. Briefly explain issues that are relevant to the auditor's assessment of RMS Ltd's going concern status in the current audit.