Planning and Delivering the Audit

200535 Auditing and Assurance Services

Question:

Planning and delivering the audit

You are one of two partners at Diligence Chartered Accountants, a small, specialist audit firm based in the Central West of NSW with clients in the aged care, retail, tourism, agri-business, local government, community banking, and education sectors. It’s a snowy Thursday evening in early July 2021 and you’re meeting with your audit team—Kel Richards (Manager), Sally Neilson (Senior), Kristin Jensen (Graduate), and Josh McDowell (Undergraduate) to review the working papers and follow up on some issues from the recently completed interim audit on Inland Dominion Enterprises (IDE) Pty Limited before beginning the final audit in mid-August. Kristin and Josh only began audit work this year, Sally and Kel are very experienced and have been with Diligence for 8 years.

IDE is a conglomerate, privately owned by twin brothers Barry and Neville Joffe. With a background in farming, the Joffe brothers have operated Mayfield Agricultural for more than twenty years before establishing IDE in 2016 to enable them to secure controlling stakes in sheet metal fabricator Small Town Steel and tourism operator Hockeys Resorts over the last 5 years.

1. Barker DeYoung—analytical procedures (440 words)

Barker DeYoung sells high-quality, moderately priced clothing for women and girls in 9 large regional cities across Victoria (2), NSW (4), and Queensland (3). Each of the retail outlets is run by local managers but purchasing decisions for all stores are handled by Francis Spurgeon, the Chief Operating Officer (COO) who was appointed after IDE gained a controlling stake in Barker DeYoung.

The industry has always been competitive but the drought (particularly in NSW and Queensland) and COVID-19 (particularly in Victoria) has placed added pressure on the business over the past 18 months, with Barker DeYoung heavily dependent on its summer range for a disproportionate share of its sales and profits. Francis Spurgeon is constantly monitoring cash flow and negotiating with suppliers about payment terms and with banks about interest rates and extensions of credit.

A major long-term debt is due for repayment 2 months after the end of the 30 June financial year, but Francis is having trouble obtaining approval from Barker DeYoung’s current bank for a renewal of the debt for a further two-year term. After their historic lows, interest rates are just beginning to increase again, adding at least 1.5% to the rate for the new debt if it is approved.

The seasonality of the business means that inventory levels fluctuate considerably. On 30 June Francis placed pre-paid orders for the summer range with the goods due to start arriving in retail outlets by August.

Required

Your Audit Senior, Sally Neilson has been given the task of assessing the liquidity and solvency of Barker DeYoung.

In your discussion with Sally:

Identify the liquidity and solvency issues that Barker DeYoung faces. Explain the likely impact of each issue on the usual liquidity and solvency ratios. advise her about the audit risks for Barker DeYoung and suggest how she could take these into account in the audit plan.

2. Small Town Steel—sampling methods and projecting errors (440 words)

Small Town Steel is based in Molong, NSW, and produces a range of high-quality steel fabrication products including tubes, pipes, plates, fasteners, and fittings for the industrial, commercial, and residential sectors. Sales to the commercial sector have been steady but thanks to a mining and building boom, sales to the industrial and residential sectors have doubled in the past year. Property, plant, and equipment (PPE) is one of Small Town Steel’s most material balances. During her planning for the audit of PPE your Graduate, Kristin Jensen, notes a major investment in a new manufacturing process. This is supported by her preliminary analytical procedures which indicate an increase in acquisitions of PPE.

As per her interim audit procedures, Kristin tested the appropriateness of the depreciation rates assigned to PPE, and whether it is consistent with the present condition and expected use of the assets over the remaining life. Kristin sampled 28 PPE items, with a total dollar value of $1,325,000. The results show that for the sample items some depreciation rates were too low and/or the remaining useful life of the equipment was overstated by management. Together these issues produce an error in the sample of $63,500. Small Town Steel has a profit before tax for the current year of $1,673,000 and a PPE balance at the end of the year of $10,325,000.

Required:

Discuss with Kristin the: appropriate method of sampling PPE for the planned tests of depreciation and population definition. assertion(s) most at risk. expected conclusion about the assertion(s) at risk with evidence to support that conclusion.

3. Small Town Steel—components of internal control (440 words)

In October 2020 Small Town Steel installed an off-the-shelf costing system to support the cost-sensitive nature of its product designs. The new system replaced a system that had been developed in-house as the old system could no longer keep up with the complex and detailed manufacturing costing processes to provide tender costings. The old system also had difficulty with the company’s broader reporting requirements. Small Town Steel’s IT department, together with consultants from the software company, implemented the new manufacturing costing system. There were no customised changes, but the key operational staff and their internal auditor were significantly engaged in the selection, testing, training, and implementation stages. The manufacturing costing system uses all the manufacturing unit inputs to calculate and produce a database of all product costs and recommended sales prices. It also integrates with the general ledger each time there are product inventory movements such as purchases, sales, wastage, and damaged stock losses.

Required

osh McDowell, your Undergraduate, has been assigned to assess Small Town Steel’s IT controls with particular emphasis on the recent implementation of the new IT manufacturing costing system. Brief Josh with regards to: identifying and evaluating two (2) components of internal control. comparing the approaches the internal auditor and we, as external auditor, would take to assessing these components in relation to the new manufacturing costing system.

4. Mayfield Agricultural—sales and receivables testing (440 words)

Kristin Jensen and Josh McDowell were assigned responsibility for auditing the accounts receivables ledger. Their focus has been the posting of entries for sales and sales returns and they have taken a predominantly substantive approach because although controls at Mayfield Agricultural are generally good, the large dollar value and infrequent nature of sales and trade receivables means it’s more efficient to test substantively rather than test controls. One of the steps in the audit program is to compare the credit memo and supporting documents with the entries to debtors for sales returns and allowances in relation to dates, customers, products, quantities, prices, and amounts. Kristin and Josh checked all credit memos with dates of up to and including 30 June and report that they have found nothing unusual.

Required

Kel Richards is reviewing the working papers completed by Kristin and Josh but you have also had a look at the file. Explain to Kel: why Kristin and Josh need to account for the numerical sequence of sales invoices, credit (sales returns) memos, and shipping documents. why Kristin and Josh will need to examine credit memos with July dates before they can conclude on whether there any issues. why he should undertake some audit procedures himself and the types of things he should be looking for when performing these procedures. other procedures that are best performed by a more senior auditor.

5. Small Town Steel—test of details and CAATS (440 words)

Small Town Steel also designs and manufacture custom-designed tools for special purposes in the mining industry. The custom-designed tools are made only on the signing of a contract and receipt of a deposit whereas the standard products are supplied to regular customers on receipt of a telephone order. Small Town Steel’s sales transactions vary from a few dollars to millions of dollars depending on the number of items sold, whether the individual items are large or small and whether the products are standard or custom-designed tools. Required Sally Neilson has been asked to gather evidence about the sales transactions using sampling and vouching. Outline and justify your expectations for: the content of the audit program in relation to sample selection and vouching procedures. CAATs that could be used to help gather the evidence, including at least one feature of Active Data for Excel.

6. Hockeys Resorts—independence issues (550 words)

The CEO of Hockeys Resorts, Charlotte Pidgeon, has approached you about undertaking an engagement to value the entire Port Douglas resort for the purposes of securing new finance. Given the impact of COVID-19 on the tourism industry she has suggested that the valuation engagement be undertaken without charging a fee as a gesture of goodwill. Before IDE gained a controlling stake in Hockeys Resorts, Diligence Charted Accountants did undertake valuation work at their resorts. The current value of Hockey Resorts is material to IDE. When discussing the issue with the audit team, Josh McDowell informs you that he was given a small parcel of shares in Hockeys Resorts three years ago by his uncle as an 18th birthday present.

Required

With reference to APES110: identify and explain the potential independence threats to Diligence Chartered Accountants propose actions your firm should take to eliminate the potential threats to independence and reduce the risk of similar independence threats occurring in the future.

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