THE AUDIT OF RUSSELL LIMITED
AIMS:
The aims of this case study are:
1. To demonstrate the different phrases of an audit.
2. To demonstrate how the audit process is documented.
3. To illustrate specific audit techniques.
OBJECTIVES:
On completion of this case study, you should be able to:
1. Evaluate audit risks exposure.
2. Critically analyse situations which will impact on the audit process.
3. Analyse strengths/weaknesses in internal controls.
4. Evaluate audit evidence.
5. Document audit findings.
SCHEME OF WORK:
1. The case documentation is presented in two segments:
- Introduction and background to the company.
- Assignments, together with any additional documentation necessary for their completion.
2. For each question, students should prepare fully detailed and written answers as though they are for inclusion in an audit working paper file.
3. Detailed instructions will be given for each section of the work required to be completed.
HOW TO STUDY THE AUDIT CASE
An audit case is in many ways similar to a tutorial. If you are going to benefit fully from the arguments and discussions about the case, not to mention give a good account of your own opinions, you must be well prepared before the tutorial discussion. In effect, you must place yourself in the role of the senior on the audit engagement. You must plan the audit, design the programs and perform the work as called for by the facts as you interpret them. You must also be able to identify and discuss important practical auditing issues arising from the assignment.
The case consists of several pages of prose description dealing with the company background and accounting controls and procedures.
There are several common techniques of case writing which are important for you to understand. These techniques are necessary as the case writer has in effect represented you at the meetings and discussions with the client. Since you were not present to judge the facts for yourself, the case writer must signal to you the quality of the evidence, or information that was obtained, on which you must base your decisions.
Any simple factual statement such as "the company was incorporated in 19xx", or that "the company manufactures furniture" may be accepted as "true" in the sense that the facts are readily ascertainable and verifiable. Whereas, a statement such as "costs and calculations are performed by Mr XXX" is more likely to be what you would have been told if you were there. It may or may not be true - audit tests will have to be performed to prove the statement. Similarly a statement such as "the stocks were properly counted" is only the opinion of the observer based on what was seen. It does not guarantee that no errors were made.
Quotations by or statements attributed to a person can be accepted as having been made by the person, but not necessarily as true. Further evidence may have to be sought elsewhere on the case documentation before the opinions can be accepted as true or false. Generally statements attributed to the audit team have more reliability than those attributed to the client or third parties.
Steps in the Study of the Audit Case
1. Read the information provided, general instructions and preparations through once very quickly to familiarise yourself with the company and the characters involved.
2. Briefly review the requirements for theassignment to give yourself an understanding of what you will be required to do.
3. Read background information in details a second time noting important facts and opinions and their relevance to particular assignments. This effort is well worth the time spent as the assignments are based on the case information provided in the background material as well as relevant information contained in the various assignments.
As those in practice know full well, you cannot perform an effective audit if you do not know the client's business.
4. The Schedules should be completed as if they were to be included in audit working papers in practice.
5. Any procedures or matters included in the assignment which you do not understand should be discussed with your tutor at the relevant tutorial discussion.
QUESTION 1: NEW CLIENT ACCEPTANCE AND AUDIT PLANNING
Background of Russell Ltd
"We have a fairly good year", said the Managing Director (MD), John Claddy of Russell Ltd. "The sales for this year exceeded $2 million for the first time in our history, though net profit didn't keep pace with the sales increase because of higher labour costs."
Russell Ltd is a manufacturing company. Its factory is located in Greymouth, including a sales branch and warehouse facilities. The company also have sales branches in Auckland, Wellington, Christchurch, Perth and Adelaide. It currently exports to Indonesia and India. The company is looking into selling to China and South Korea to expand its markets. It has over 80 full-time employees. The factory is owned by Russell Ltd and the sales branches are on leased premises.
The company products are specialised industrial chemicals divided into 'Product Line A' and 'Product Line B'. Due to the technical developments and competitive industry the products are subject to a substantial obsolescence risks. If a product becomes obsolete, the company is often able to sell the chemicals to other manufacturers for their use. However, Russell Ltd will generally only receive 40c in a dollar for the product.
Russell Ltd was established in 1985 by John Claddy the MD, who is also a chemical engineer. John Claddy is considering retiring in five years time and his son Simon Claddy, the current factory manager, will take up the role of Managing Director. Simon has worked his way up from being a factory worker to his current position. He is therefore familiar with the factory processes, health and safety protocols and quality control processes. The production development manager is James Williams. He joined the company five years ago. James has a Master Degree in Chemistry engineering, and he also has extensive knowledge and experience in the industrial chemicals industry.
The industrial chemicals industry is vast and essential for the global economy. It produces essential raw materials for other manufacturer sectors, such as chemicals used in producing soaps and detergents; chemicals for paints, coating and surface treatment; and chemicals for plastic products, textiles and cosmetics etc. Russell Ltd specialises in producing industry chemicals used in manufacturing adhesives and sealants (Product Line A) and chemicals for manufacturing plastics (Product Line B). The company has patented the production process for Product Line A.
The booming building industry in some major cities in Australasia led John and Simon to consider expanding the business, by researching the feasibility of a new product line that produces chemicals used in paints, coating and surface treatment. James is currently leading a group of people in researching the production processes for the new production line. Sales manager Alice Wilson is conducting a market research for the new products. If the research results show that the new production line is feasible, the company will need additional finance from financial institutions at the end of the current financial year (ending 30 June 2016). Moreover, to keep Russell competitive within a market with increased awareness of environmental sustainability, the company continues to research and to refine its products and production processes to produce safer products and to minimise toxic waste.
The company's four senior management officers (the managing director, the sales manager, the product development manager and the factory manager) manage the company in a highly individualistic manner. All four officers sit on the Broad of Directors together with the Financial Controller Emma Glover and two independent directors, namely Matt Hamilton a professor in chemistry and Ashlyn Kim a lawyer. Emma Glover is John's niece. The shareholding structure of the company is according to the table below.
The company's accounting functions are concentrated at the factory. The sales branches and warehouses maintain only payroll, petty cash and inventory records, which are subject to review by the head office. Branch managers are responsible for reconciling inventory held at their branches and for signing off the monthly payroll cards. The company has relatively low turnover of staff because of the staff benefits offered to employees and the good leadership. The company's accounting system is a system which is separate from the production management system.
The company is closely held by the Johns family and until recently, there has not been any requirement for a financial audit. However, the company has an internal audit function, which mainly focused on auditing the processes of productions, safety, and waste disposals in order to fulfil industry regulations. As a result of company growth and John's and Simon's intention of having the company listed on the NZ Stock Exchange within a decade, a decision was made to have the company's financial statements audited. The company therefore approached you, an audit partner of Patterson & Partners to audit the company.
Patterson & Partners is a second-tier accounting firm in New Zealand. It offers assurance, advisory and tax services. There are 60 partners New Zealand wide. You have limited knowledge about the specialised chemical industry, however the senior manager of the firm, WongKang used to be a senior accountant in a specialised chemical manufacturer. Moreover, some of the partners of Patterson & Partners do have clients in the industry and the firm has resources about the industry and its trend. During your meeting with John and Simon, they also asked you to provide valuation services for their research & development expenditures. John and Simon are willing to give the auditors full access to their business information and any relevant personnel during the course of auditing. John and Simon also offered a bonus of $30,000 on top of the audit fees if an unqualified opinion is given. Financial information for the years ended 30 June2016, 2015 and 2014 are given in the Excel Spreadsheet available on Blackboard.
QUESTION : Understanding the internal control process, assessing control risk and inventory management system of russell ltd.
QUESTION 1: NEW CLIENT ACCEPTANCE AND AUDIT PLANNING
a. Evaluate whether you should accept Russell Ltd as your audit client. Present your answer in the given format below.
|
Factors for evaluating a new client
|
Explain why the factor needs to be considered
|
How does this factor impact on your client acceptance decision
|
|
|
|
|
b. Based on your analysis above, explain whether you would accept Russell Ltd as a client. [2 marks]
c. Assuming that you decided to accept Russell as an audit client, prepare detailed notes on the company that cover the following
1. Identify those areas of audit concerns which should be emphasised during the audit. Where relevant, support your answer by calculations of appropriate ratios and/or comparisons.
2. How do those identified concerns impact audit risks?
3. What strategies would you undertake to overcome the areas of concern?
|
Audit risk factors
|
Potential impact on financial statements and audit risk
|
Strategies to overcome the risks identified
|
|
|
|
|
Present your answer in the following tabular format.
QUESTION 2: understanding the internal control process, assessing control risk, audit procedure for inventories
Identify four control weaknesses in the inventory system of Russell Ltd. Explain how each weakness may affect the financial statements and identify the audit procedures to address the control weakness.
a. You are required to present your answers according to this format:
|
Identify a control weakness
|
How the weakness may affect financial statements
|
Audit procedures to address the control weakness
|
b. Identify three control strengths in the inventory system of Russell Ltd and explain why each control is a strength. For each control strength, identify audit procedures to test the effectiveness of control. Use the format to present your answers.
You are required to present your answers according to this format:
|
Identify a control strength
|
Why it is a strength
|
Audit Procedures to test the control
|
c. Assuming the control risk is medium, explain substantive audit procedures for verifying inventory at year end. The substantive procedures should address the following assertions, and explanation should be given for the procedures.
You are required to present your answers according to this format:
|
Assertions
|
Audit procedures
|
Details and rationale of each procedure
|
|
Existence & Occurrence
|
|
|
|
Completeness
|
|
|
|
Accuracy & Valuation
|
|
|