Part A:
Consider the following independent situations:
1. You have established an audit practice with two separate divisions: account preparation and audit. Each division has a different partner and staff team. Your firm commonly prepares financial accounts and conducts audits. Your firm has recently been provided with a trial balance from a listed client Green Pastures Ltd, for whom your firm is preparing the financial accounts and conducting the audit. The client has significant expertise and approves all adjusting journal entries.
2. Samuel Rose is part of the audit team for the current audit of Saturn Ltd. After 2 weeks at the client, he has advised you that he has been offered a job at Saturn Ltd as soon as the current audit is finished.
3. One of your major clients, Fresh Juices Ltd, has talked to you about a consulting engagement next year for you to do a complete review of the adequacy of the entity’s quality controls over the production of its fruit juices. However, the managing director has indicated that some of the Board are concerned about you taking up too much of their staff’s time asking unnecessary questions. Therefore, he has suggested that your chances of getting the engagement will be significantly improved if you keep your questions of staff to a minimum during the current audit.
4. You have audited Excelsior Ltd, a stable engineering firm, for several years. At the start of this year, the finance director, Susan James, retired after 10 years with company and was replaced by Steve Price, a long-time friend of the audit manager Geoff Holmes, who was best man at Steve’s recent marriage.
5. One of your audit clients, My Super Ltd (MSL) is a large superannuation fund. The Australian Taxation Office has advised MSL that it has rejected its taxation treatment of a material amount of income from investments and that it disagrees with the taxation advice MSL gave to its members. The matter has been referred to the Superannuation Complaints Tribunal and MSL has requested that you represent them at the Superannuation Complaints Tribunal.
REQUIRED:
For each of the independent situations above:
(a) Identify the type of potential threat to independence. Justify your answer.
(b) Explain what safeguards, if any, that could be implemented to reduce the independence threats.
(c) Assess whether audit independence can be achieved.
You may like to present your answer in the form of a table.
Part B:
You are currently planning the audit of Food Plus Pty Ltd (FPPL), a large proprietary company that operates a small chain of convenience stores. You are in the process of developing an understanding of its objectives and strategies and the related business risks. Competition in this sector is intense, with major supermarket chains aggressively purchasing smaller rivals and discounting products below cost in order to increase market share. In order to compete, FPPL has been forced to offer value-added services such as complimentary coffees based on a loyalty scheme. While these strategies have helped to maintain its customer base, its gross margins have dropped by 10%. In an effort to increase profits, FPPL has recently focused on expanding the products available in each store. However, these items have achieved only limited acceptance to date among FPPL’s customers and stock obsolescence is high.
All of FPPL’s premises are leased. Two of the leases are due to expire prior to the end of the current financial year. In both cases, the land on which the premises are situated has been re-zoned as residential. Due to “prior use” legislation, this does not prevent the premises from being used as a supermarket in the future. However, it does mean the land’s value has increased and, on this basis, the lessor is demanding a 50% increase in rent. FPPL is also experiencing difficulties with two of its major suppliers, who have withdrawn their volume rebates and reduced payment terms from 30 to 14 days. In addition, FPPL has recently initiated legal action against a major supermarket chain for anti-competitive behaviour and predatory pricing.
REQUIRED:
(a) Identify five (5) business risks, as per ISA 315, which may lead to the risk of material misstatement at the financial statement level for FPPL.
(b) For each business risk you identified in (a) above, describe how it may lead to the risk of material misstatement at the financial statement level.
You may wish to present your answer to (a) and (b) using the table.
Part C:
Background information:
You are currently planning the 30 June 20X5 audit of Super Grain Ltd (SGL), an Australian-owned company that produces and exports genetically modified grains to China. The production of genetically modified food products has angered environmental groups. Protests have been held at several of SGL’s farms, which has slowed production. As a result, several grain shipments have been delayed, angering the Chinese customers who are threatening to deduct 25% from amounts owing as compensation for their lost production time. A recent slowdown in the Chinese economy is also affecting forward orders, which have fallen by 20%.
A protester was injured recently when she was hit by farm machinery while trying to block the harvesting process. The protester is now suing SGL for damages, claiming the machinery operator was negligent and was acting on SGL’s instructions. SGL is vigorously defending the case and appears to have a reasonable chance of winning; however, the adverse publicity being generated is making the government nervous about extending SGL’s licence for producing genetically modified products. One of SGL’s Chinese customers, Super Flour, is claiming that the latest shipment of grain that it received was contaminated with a microbe due to the genetic modification that significantly reduced its quality and causing it to recall the flour that it was used to manufacture. Super Flour is refusing to pay its account, which is already three months overdue. SGL has launched an investigation into the allegations, but as yet has not been able to substantiate them.
At the start of the year, SGL upgraded its accounts payable system to a fully integrated package that automatically updates the general ledger when creditor entries are made. SGL has experienced some problems with the creditors ledger, which is split into $US and $AUD amounts, as SGL purchases its genetically modified seeds from the United States. In some instances, $US amounts have been recorded
as $AUD, resulting in inaccurate creditor balances. There have also been problems with month-end rollovers with creditor balances being incorrectly re-set to zero at the first of every month. This has required each creditor’s history to be re-entered manually each month, a time-consuming process that is taking accounting staff away from their normal duties.
PART C.1 REQUIRED:
(a) For each of the following items in SGL’s financial statements, identify two (2) factors in the information provided that increase audit risk:
a. Accounts Receivable
b. Inventory
c. Accounts payable
d. Contingencies
(b) Describe one (1) adjustment to be made to your audit plan in response to the audit risk associated with each of the factors identified in part (a).
You may wish to present your answer in a table format.
PART C.2
Relevant to background information in Part C above, shortly after the audit plan was approved for the current year, a severe flood caused extensive damage to several of SGL’s farms. Stock was damaged and buildings and equipment destroyed. Repair costs will be significant. Important documents and accounting records were also lost at several locations. The loss of profits for SGL will be several million dollars.
SGL has lodged claims with its insurer and the claims are currently being assessed. SGL is unsure whether the insurance policy will cover all the losses, as flood claims are always complex. While the CEO, Billy Hansen, has indicated that he is confident that SGL will be able to rebuild its operations, he has indicated that it will be very difficult if the insurance claims are rejected, as SGL would then need to raise additional capital or obtain additional loan funds.
PART C.2 REQUIRED:
Outline four (4) reasons why the audit plan will need to be revised.
Part D:
Kiddies Heaven Ltd (KHL) is a toy manufacturer. KHL has factories across the country and its customer base includes retailers, as well as individuals, to whom direct sales are made through their website. You are an audit senior at Graham & Associates and you are currently reviewing documentation of KHL’s internal controls in preparation for the interim audit. KHL’s website allows individuals to order goods directly and full payment is taken in advance. Currently the website is not integrated into the inventory system and inventory levels are not checked at the time when orders are placed.
Goods are delivered via local couriers; however, the couriers do not always record customer signatures as proof that the customer has received the goods. Over the past year, there have been customer complaints about the delay between sales orders and receipt of goods. KHL has investigated these complaints and found that, in each case, the sales order had been entered into the sales system correctly, but was not forwarded to the despatch department for fulfilling.
KHL’s retail customers undergo credit checks prior to being accepted and credit limits are set accordingly by sales ledger clerks. Neither the sales area managers nor the sales director are involved with this process. These customers place their orders through one of the sales team, who decides on sales discount levels.
Raw materials are purchased from a wide range of suppliers. As a result of staff changes in the purchase ledger department, supplier statement reconciliations are no longer performed. Additionally, changes to existing supplier details or inclusion of new supplier details in the purchase ledger master file can be undertaken by purchase ledger clerks, as well as supervisors. In the past six months, KHL has changed part of its manufacturing process and as a result some new equipment has been purchased. However, there are now considerable levels of plant and equipment that are now surplus to requirement. Purchase requisitions for all new equipment have been authorised by production supervisors and little has been done to reduce the surplus of old equipment.
REQUIRED:
a) Identify five (5) deficiencies in the internal controls of KHL. Explain how a business risk arises from each deficiency.
b) Describe a control which KHL could implement to address each of these deficiencies.
c) Design a test of control Graham & Associates would perform to assess if each of those controls identified in (b) above is operating effectively.
You may wish to present your answer in a table format.