Professional Practice-Auditing and Risk Assurance

Question 1

The following financial ratios have been calculated for Nova Ltd for the year ended 30 June 2020:

  Actual
results
Budgeted results Previous
year
Industry average
Current ratio 1.97 1.92 1.87 1.92
Quick asset ratio 1.06 1.06 1.06 1.11
Inventory turnover 4.21 4.91 4.86 4.76
Net profit ratio 0.05 0.03 0.03 0.03
Gross margin 0.65 0.59 0.61 0.61

Required:

Provide four (4) possible explanations for the results for the various ratios for Solar Ltd and outline their implications for the audit.

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Question 2

You have reviewed the work performed by your assistant, Raymond Snow, on the audit of Tin Ltd for the year ended 30 June 2020 and have noted the following two independent matters:

(i) In testing investments in listed securities, Raymond selected all shareholdings with a market value above $200,000 and checked them to the closing market value reported by the Australian Stock Exchange to determine the net realisable value of each shareholding.  The items tested totalled $5,500,000 or 60% of the total balance.  Of the items tested, only one error of $110,000 was discovered.  Raymond concluded that the error was not itself material, as it was only 2% of the balance tested.  He extrapolated this error to the total population and estimated that the error for the total population would be $185,000, which was also immaterial.  Therefore, he concluded that the investments in listed securities were fairly stated at the lower of cost or net realisable value.

(ii) Tin Ltd has 1,000 stock lines that are maintained on a perpetual inventory system.  Stock is counted on a cyclical basis so that all lines are covered at least once per year.  Raymond attended the March stocktake to observe the counting procedures and conducted 20 test counts from the floor to the client’s count sheets and 20 from the client’s count sheets to the floor.  He uncovered two minor discrepancies of one item each, which he considered to be immaterial.  The client also uncovered five minor discrepancies between the perpetual records and the actual quantity on hand.  None of these discrepancies were adjusted on the perpetual records, as the amounts involved only totalled $50,000 and were considered to be immaterial.  Raymond concluded that no further work was considered necessary on stock quantities at year end.

Required:

(a)Explain what is meant by sufficient appropriate audit evidence.

(b)Explain whether sufficient appropriate audit evidence has been obtained for each of the above situations. Give reasons for your answer.

Question 3

You are planning the audit of Budget Pty Ltd, which is a subsidiary of Premium Ltd. It was established to provide the group with access to the growing budget wine market. However, Budget Pty Ltd has found trading conditions difficult due to the current wine glut and has sustained significant losses and has a negative cash flow.

The CEO of Budget Pty Ltd, Anne Hale, has indicated that there is nothing to worry about as Premium Ltd has signed an agreement to support the company for as long as it takes to establish a presence in the budget wine market.

Budget Pty Ltd has an internal audit function that is attached to the accounting and finance division, and reports directly to the finance director in his capacity as chair of the audit committee.

During your review of internal audit, you have noted the following matters:

(i)The staff of the internal audit function changed significantly during the year. The division employed three new staff to undertake the testing of the financial accounting records, while the more senior personnel who had previously done these tests concentrated on the performance auditing schedule of the internal audit function. The new staff had no previous audit or accounting experience.

(ii)The work that has been documented appears to be quite thorough and competent. However, for some of the audit tests prescribed, the staff have not prepared detailed documentation of the work that has been completed. They have simply initialled the audit program and noted that the test has been satisfactorily performed.

Required:

(a) Outline your assessment of the appropriateness of the going concern basis for Budget Pty Ltd. Justify your assessment.

(b) Indicate three (3) audit procedures that you would undertake in relation to this going concern issue.

(c) Provide your assessment as to whether the external auditor can rely on the work of internal audit. Give reasons.

Question 4

While completing your audit work for the 30 June 2020 audit of Grape Ltd, you become aware of the following material matters:

(i)On 5 July, Red Pty Ltd, a major customer of Grape Ltd, was placed into liquidation. As Red Pty Ltd had confirmed the balance due to Grape Ltd as at balance date, management of Grape Ltd has refused to write off or provide for the Red Pty Ltd account in the 30 June 2020 financial report. However, they are prepared to disclose this information as a note to the financial report.

(ii)On 15 July, Grape Ltd entered into a new contract to supply wine to Wine Taster, a major new wine store that had set up operations in northern Queensland.  The contract was similar in nature to other contracts previously negotiated with other wine stores. Management does not believe that any change to the financial report is required.

(iii)Grape Ltd has capitalised significant funds incurred in developing an improved new wine cap that allows the wine to continue to develop in the bottle.  On 20 July, Grape Ltd applied for a patent for the cap, only to discover that a competitor had lodged a similar application on 15 June.  The granting of Grape Ltd’s patent application is now in serious doubt. Management do not believe any change to the financial report is required.

(iv)A note to the financial report of Grape Ltd refers to an agreement to sell its major subsidiary, Cleanskins Pty Ltd, to a rival wine company. This agreement was finalised the day before the financial report was to be signed and the sale is to take place a month after the audit report is to be signed. You have verified this transaction. However, when reviewing the ‘Chairman’s Review’, which is to be included in the annual report that contains the audited financial report, you see that:

(a) plans for expanding Cleanskins Pty Ltd’s facilities are outlined;

(b) the additional revenue to be generated over the next ten years as a result of this expansion is tabulated; and

(c) there is no reference to the sale of Cleanskins Pty Ltd.

Management believe that it is too late to make any changes to the annual report, as it is ready to send to the printers, as soon as the audit report is signed.

Required:

For each independent situation, state the type of audit report that you should issue and give reasons for your answer.

Question 5

You have just completed the audit fieldwork on Pioneer Pty Limited for the year ended 30 June, 2020. The following summary points have been raised on the audit completion summary.

(a)Going concern—the company and the economic entity have incurred substantial trading losses for the current year. While the company and the economic entity still have a positive net asset position, further losses in future years may result in the deterioration of the capital base. The continuation of the company and the economic entity as a going concern is dependent on the continued financial support of the company’s bankers and the ability of the trading businesses within the economic entity to generate a positive cash flow.

Discussions with the bankers indicate that it is their present intention to continue to support the group in the hope that the group can reverse its current trading position.

The following historical information is relevant.

   

Turnover

$’000

Profit/(loss)

after tax

$’000

Net current

Assets/(liab)

$’000

 

Net assets

$’000

2020 20,000 (4,000) (500) 3,200
2019 25,000 (1,000) (200) 7,200
2018 26,000 1,000 400 8,200
2017 24,000 2,000 600 7,200
2016 22,000 5,000 800 5,200

A review of the company’s budget in respect of future trading periods indicate that the reversal in trading performance will be gradual and is expected to take at least five years.

(b)Stock valuation—the audit of stock valuation identified two issues;

(i)Use of LIFO basis—the company used the LIFO basis of valuation of closing inventories. Had the client used the FIFO basis of valuation, the value of closing inventories would be increased from $2,000,000 to $2,500,000.

(ii)Provision for stock obsolescence—the client has failed to make any provision in respect of stock obsolescence. The audit work has raised serious questions about the valuation of the company’s spare parts stock. The auditors were not able to quantify a provision. The total value of the spare parts stock is $300,000.

These matters were discussed with the client, who has refused to take any action on these points and has given you the following responses:

Going concern—it is management’s view that the company is a going concern and they do not intend to include a note in the financial report in respect of accounts preparation. The directors’ declaration will not be qualified.

Stock—the company believes that the use of the LIFO method for the valuation of inventory is more appropriate to the company’s operations and, therefore, no amendments are contemplated. Further, management do not believe it is necessary to make any provision in respect of the spare parts inventory.

Required

Prepare a report to the audit partner outlining the effect that each of the above issues is likely to have on your audit opinion.

 
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