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Question 4b

You are a manager in Beck & Co, responsible for the audit of Kobain Co, a new audit client of your firm, with a financial year ended 31 July 2012. Kobain Co’s draft financial statements recognise total assets of $55 million, and profit before tax of $15 million. The audit is nearing completion and you are rewiewing the audit files.

Kobain Co designs and creates high-value items of jewellery. Approximately half of the jewellery is sold in Kobain Co’s own retail outlets. The other half is sold by external vendors under a consignment stock arrangement, the terms of which specify that Kobain Co retains the ability to change the selling price of the jewellery, and that the vendor is required to return any unsold jewellery after a period of nine months. When the vendor sells an item of jewellery to a customer, legal title passes from Kobain Co to the customer.

On delivery of the jewellery to the external vendors, Kobain Co recognises revenue and derecognises inventory. At 31 July 2012, jewellery at cost price of $3 million is held at external vendors. Revenue of $4 million has been recognised in respect of this jewellery.

Required:

Comment on the matters that should be considered, and explain the audit evidence you should expect to find in your file review in respect of the consignment stock arrangement. (6 marks)