Auditing Requirements:
You are audit senior in the audit firm Greentick, in charge of the audit of Soundworld Ltd for the year ended June 30, 2016. Prepare a report dated February 1, 2016 for the audit manager outlining the audit plan for the year ended 30 June, 2016. As it is the beginning of the audit do not prepare a final audit report/opinion. The report should cover the following areas under the suggested headings:
Planning Materiality
Calculate the planning materiality and provide two reasons justifying the base you have chosen for your calculation.
Refer to additional information.
Risk Assessment
The audit team has gained an understanding of Soundworld Ltd's structure and business environment as a part of the risk assessment phase of the audit. From researching the retail and wholesale electronics/entertainment product industry, a number of inherent risks have been documented and recorded in the additional information provided with the assignment.
In your report include the documented ‘Risk Description' with an additional heading ‘Risk Assessment'.
Under this heading for each of the inherent risks documented, consider Soundworld Ltd's operations with reference to the information provided in the assignment and identify the associated financial accounts that would be affected.
For each of the financial accounts identified provide an assessment of ‘high', ‘medium', or ‘low' in relation to the likelihood and materiality of the risk of misstatement of the account balance occurring in Soundworld with reasons for your assessment
Identify the relevant ‘assertion/s' which could be affected. Assertions as per text pages 164-165.
For example-"the sales account balance has a ‘high' inherent risk of being misstated as the company needs to generate sales to meet published profit forecasts. The relevant assertion is ‘occurrence' to ensure that sales are real and have not been overstated."
Analytical Procedures
In undertaking the risk assessment of Soundworld Ltd the analytical procedure using ratio analysis has also been completed and documented in the additional information provided with the assignment.
Discuss the results of the analytical procedures outlining potential problem areas (that is, where possible material misstatements in the financial report exist) and any other special concerns (for example, going concern). Specify the account balances and related assertions that would require particular attention in the audit.
Conclusion
Include a final conclusion recommending the areas of audit focus based on the risk assessment processes undertaken in the previous sections.
Additional Information
General Information
Soundworld Ltd is a publicly listed company. The company is an established wholesale distributor of electronic goods such as CDs, DVDs, TVs, home audio systems, computers and other mobile devices.
The company operates in a competitive industry. The company has consistently increased profits up to 30 June, 2014 providing shareholders with a consistent dividend stream.
During the year ended 30 June, 2015, the company opened a retail outlet in a major shopping centre in Newcastle on 1 April, 2015 with a material expenditure on media coverage promoting the new store and a continued advertising campaign resulting in an increase in promotional expenses.
To finance the store costs and expansion of the existing warehouses Soundworld Ltd borrowed an additional $1 750 000 in March 2015.
Based on actual figures for the first six months ended 31 December, 2015 the company released to the public, a forecast of a 4% improvement in profits for the year ended 30 June, 2016.
During the current year there have been some thefts of merchandise from the store requiring to the installation of closed circuit television cameras and the employment of security staff. There have also been some concerns regarding the handling of cash by staff requiring a review of internal controls.
Financial Information:
Account 30 June 30 June
2015 2014
Revenue 44 944 470 43 750 000
Borrowing Costs 850 300 531 438
Other Expenses 43 073 810 41 517 962
Profit before income tax 1 020 360 1 700 600
Accounts Receivable 12 841 217 11 513 158
Inventory 7 515 890 6 895 650
Interest Bearing Liabilities 10 345 000 8 595 000
Ratio Analysis
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Liquidity ratios
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2015
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2014
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Quick ratio
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0.89
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1.3
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Current ratio
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CA/CL
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2.10
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2.64
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Inventory turnover
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COS/Ave Inventory
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2.9
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3.6
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Accounts receivable
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Credit sales/Ave Receivables
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3.50
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3.8
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Solvency ratios
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Debt to equity
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Liabilities/equity
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5.5
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3.15
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Times interest earned
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Op profit bf interest and tax/interest expense
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1.2
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3.2
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Profitability ratios
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Gross profit ratio
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Gross profit/sales
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0.55
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0.52
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Net profit ratio
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Net profit/sales
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0.02
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0.04
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ROA
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Net profit/ave total assets
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0.02
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0.06
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Return on Shareholder funds
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Net profit/ave common shareholders equity
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0.05
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0.15
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Risk Assessment to Be Included in the Report.
The following inherent risks have been identified in respect of Soundworld Ltd:
Revenue Growth
Risk Description
Consumer spending is low and expected to grow by only 1% for the year and is lower than initial budgets for revenues. Bonuses are paid to management on the basis of revenue targets.
A new credit policy has been implemented by the company and there have been some problems with the checking of credit of customers.
Risk Assessment
Competition
Risk Description
The wholesale business is well established and continues to compete on the traditional basis of price, brand strength and level of market power. However Soundworld's venture into the retail market is relatively new and price remains important in most high volume areas of retailing.
Inventory cycle and technological trends
Risk Description
The competiveness of the entertainment market (DVDs and music) and rapidly changing technologies can result in obsolete stock.
Misappropriation of stock and cash
Risk Description
The retail business sells highly desirable and moveable products such as DVDS laptops, etc and will be exposed to a risk of theft. In addition, employees handling cash at store locations increase the risk of theft of cash.
Rebates/Discounts to retailers
Risk Description
For the wholesale business, there is significant pressure from retailers to receive generous rebates or volume discounts in respect of the products distributed. Retailers control their profits through the supply chain and inventory levels and this could impact the wholesale business.
Learning Criteria
To identify and assess the various risks associated with a business; understanding their impact in planning an audit approach; and communicating the analysis using a report format.