Marsden Manufacturing (MM) is an established audit client of your firm. You were involved with the audit last year as audit senior. This year, you are to act as audit supervisor. The engagement partner has asked you to plan the audit for the year ended 30 June 20X4. It is an old-fashioned audit, and the partner does not anticipate that you will require the use of the new laptops that the firm has just invested in.
MM has a sales ledger of approximately 100 customers, but in terms of value, 80% of the ledger is represented by just six. The company has just secured a new customer, Wallworths, which has only impacted on the sales ledger for one month in the current year, but is projected to represent 20% of sales in the year ending 30 June 20X5.
MM has a large bank loan with ABC Bank. There is a covenant attached to the loan. One of the conditions of the loan is that the company maintains certain financial ratios at the period end. The bank requires an interest cover of 2.5 and a current ratio of 1.5.
The major development in the year is that MM decided to factor their debts. In the past they had suffered a substantial irrecoverable receivables expense when a major customer went bankrupt and they are concerned that the reoccurrence of such an event would affect their interest cover ratio. They sacked their sales ledger clerk at the end of the year, so have outsourced their sales ledger function to the factor.
The audit assistant attended the inventory count two days ago. She observed that there appeared to be a high level of old inventory. They were nevertheless added into the count.
The following draft figures have been provided.
Statement of financial position
20X4 20X3
$'000 $'000 $'000 $'000
Non-current assets 210 243
Current assets
Inventory 460 370
Receivables 324 250
Cash 15 69
799 689
Payables: amounts falling due within one year
Trade payables 381 367
Bank loan 10 10
391 377
Net current assets 408 312
Payables: amounts falling due in more than one year
Bank loan (250) (260)
368 295
Statement of profit or loss 20X4 20X3
$'000 $'000
Revenue 2,534 2,967
Cost of sales (1,583) (1,823)
Gross profit (% 37.5/38.5) 951 1,144
Administrative expenses (476) (488)
Other expenses (400) (432)
Profit before interest and tax 75 224
Interest 14 14
Sally Forsyth, the sales ledger clerk has threatened to sue MM for unfair dismissal and sexual discrimination.
Wallworths is an audit client of the firm. You are aware that they were often in dispute with their previous supplier over their poor payment record and have changed supplier because the supplier broke off relations with them.
Required
(a) Comment on the level at which you would set materiality.
(b) Identify and explain the audit risks in the above scenario for the audit for the year ended 30 June 20X4.
(c) Outline the key administrative planning matters that remain outstanding.
(d) Discuss whether an audit conflict of interest arises in this situation and what steps the auditor might take in this situation.