ACCA AA Syllabus B. Planning And Risk Assessment - Affecting Audit Risk - Past Papers ^{2 / 3}

You are an audit supervisor of Cupid & Co, planning the final audit of a new client, Prancer Construction Co, for the year ending 30 September 20X7. The company specialises in property construction and providing ongoing annual maintenance services for properties previously constructed. Forecast profit before tax is $13·8m and total assets are expected to be $22·3m, both of which are higher than for the year ended 30 September 20X6.

You are required to produce the audit strategy document. The audit manager has met with Prancer Construction Co’s finance director and has provided you with the following notes, a copy of the August management accounts and the prior year financial statements.

Meeting notes
The prior year financial statements recognise work in progress of $1·8m, which was comprised of property construction in progress as well as ongoing maintenance services for finished properties. The August 20X7 management accounts recognise $2·1m inventory of completed properties compared to a balance of $1·4m in September 20X6. A full year-end inventory count will be undertaken on 30 September at all of the 11 building sites where construction is in progress. There is not sufficient audit team resource to attend all inventory counts.

In line with industry practice, Prancer Construction Co offers its customers a five-year building warranty, which covers any construction defects. Customers are not required to pay any additional fees to obtain the warranty. The finance director anticipates this provision will be lower than last year as the company has improved its building practices and therefore the quality of the finished properties.

Customers who wish to purchase a property are required to place an order and pay a 5% non-refundable deposit prior to the completion of the building. When the building is complete, customers pay a further 92·5%, with the final 2·5% due to be paid six months later. The finance director has informed you that although an allowance for receivables has
historically been maintained, it is anticipated that this can be significantly reduced.

Information from management accounts
Prancer Construction Co’s prior year financial statements and August 20X7 management accounts contain a material overdraft balance. The finance director has confirmed that there are minimum profit and net assets covenants attached to the overdraft.

A review of the management accounts shows the payables period was 56 days for August 20X7, compared to 87 days for September 20X6. The finance director anticipates that the September 20X7 payables days will be even lower than those in August 20X7.

Required:
(c) Using all the information provided describe SEVEN audit risks, and explain the auditor’s response to each risk, in planning the audit of Prancer Construction Co.

Note: Prepare your answer using two columns headed Audit risk and Auditor’s response respectively. (14 marks)

You are an audit supervisor of Chania & Co and are planning the audit of your client, Sitia Sparkle Co which manufactures cleaning products. Its year end was 31 July 20X6 and the draft profit before tax is $33·6 million. You are supervising a large audit team for the first time and will have specific responsibility for supervising and reviewing the work of the audit assistants in your team.

Sitia Sparkle Co purchases most of its raw materials from suppliers in Africa and these goods are shipped directly to the company’s warehouse and the goods are usually in transit for up to three weeks. The company has incurred $1·3 million of expenditure on developing a new range of cleaning products which are due to be launched into the market place in November 20X6. In September 20X5, Sitia Sparkle Co also invested $0·9 million in a complex piece of plant and machinery as part of the development process. The full amount has been capitalised and this cost includes the purchase price, installation costs and training costs.

This year, the bonus scheme for senior management and directors has been changed so that rather than focusing on profits, it is instead based on the value of year-end total assets. In previous years an allowance for receivables, made up of specific balances, which equalled almost 1% of trade receivables was maintained. However, the finance director feels that this is excessive and unnecessary and has therefore not included it for 20X6 and has credited the opening balance to the profit or loss account.

A new general ledger system was introduced in May 20X6; the finance director has stated that the data was transferred and the old and new systems were run in parallel until the end of August 20X6. As a result of the additional workload on the finance team, a number of control account reconciliations were not completed as at 31 July 20X6, including the bank reconciliation. The finance director is comfortable with this as these reconciliations were completed successfully for both June and August 20X6. In addition, the year-end close down of the purchase ledger was undertaken on 8 August 20X6.

Required:
(b) Describe SIX audit risks, and explain the auditor’s response to each risk, in planning the audit of Sitia Sparkle Co.

Note: Prepare your answer using two columns headed Audit risk and Auditor’s response respectively. (12 marks)

Milla Cola Co (Milla) manufactures fizzy drinks such as cola and lemonade as well as other soft drinks and its year end is 30 September 20X5. You are an audit manager of Totti & Co and are currently planning the audit of Milla. You attended the planning meeting with the audit engagement partner and finance director last week and the minutes from the meeting are shown below. You are reviewing these as part of the process of preparing the audit strategy document.

Minutes of planning meeting for Milla
Milla’s trading results have been strong this year and the company is forecasting revenue of $85 million, which is an increase from the previous year. The company has invested significantly in the cola and fizzy drinks production process at the factory. This resulted in expenditure of $5 million on updating, repairing and replacing a significant amount of the machinery used in the production process.

As the level of production has increased, the company has expanded the number of warehouses it uses to store inventory. It now utilises 15 warehouses; some are owned by Milla and some are rented from third parties. There will be inventory counts taking place at all 15 of these sites at the year end.

A new accounting general ledger has been introduced at the beginning of the year, with the old and new systems being run in parallel for a period of two months. In addition, Milla has incurred expenditure of $4·5 million on developing a new brand of fizzy soft drinks. The company started this process in July 20X4 and is close to launching their new product into the market place.

As a result of the increase in revenue, Milla has recently recruited a new credit controller to chase outstanding receivables. The finance director thinks it is not necessary to continue to maintain an allowance for receivables and so has released the opening allowance of $1·5 million.

The finance director stated that there was a problem in April in the mixing of raw materials within the production process which resulted in a large batch of cola products tasting different. A number of these products were sold; however, due to complaints by customers about the flavour, no further sales of these goods have been made. No adjustment has been made to the valuation of the damaged inventory, which will still be held at cost of $1 million at the year end.

As in previous years, the management of Milla is due to be paid a significant annual bonus based on the value of year-end total assets.

Required:
(a) Explain audit risk and the components of audit risk. (5 marks)

(c) Identify the main areas, other than audit risks, which should be included within the audit strategy document for Milla Cola Co; and for each area provide an example relevant to the audit. (4 marks)

You are an audit supervisor of Amethyst & Co and are currently planning the audit of your client, Aquamarine Co (Aquamarine) which manufactures elevators. Its year end is 31 July 2016 and the forecast profit before tax is $15·2 million.

The company undertakes continuous production in its factory, therefore at the year end it is anticipated that work in progress will be approximately $950,000. In order to improve the manufacturing process, Aquamarine placed an order in April for $720,000 of new plant and machinery; one third of this order was received in May with the remainder expected to be delivered by the supplier in late July or early August.

At the beginning of the year, Aquamarine purchased a patent for $1·3 million which gives them the exclusive right to manufacture specialised elevator equipment for five years. In order to finance this purchase, Aquamarine borrowed $1·2 million from the bank which is repayable over five years.

In January 2016 Aquamarine outsourced its payroll processing to an external service organisation, Coral Payrolls Co (Coral). Coral handles all elements of the payroll cycle and sends monthly reports to Aquamarine detailing the payroll costs. Aquamarine ran its own payroll until 31 December 2015, at which point the records were transferred over to Coral.

The company has a policy of revaluing land and buildings and the finance director has announced that all land and buildings will be revalued at the year end. During a review of the management accounts for the month of May 2016, you have noticed that receivables have increased significantly on the previous year end and against May 2015.

The finance director has informed you that the company is planning to make approximately 65 employees redundant after the year end. No decision has been made as to when this will be announced, but it is likely to be prior to the year end.

Required:
(b) Describe SIX audit risks, and explain the auditor’s response to each risk, in planning the audit of Aquamarine Co. (12 marks)

During the planning stages of the final audit, the auditor believes that the probability of giving an inappropriate audit opinion is too high.

How should the auditor amend the audit plan to resolve this issue?

A. Increase the materiality level
B. Decrease the inherent risk
C. Decrease the detection risk

Abrahams Co develops, manufactures and sells a range of pharmaceuticals and has a wide customer base across Europe and Asia. You are the audit manager of Nate & Co and you are planning the audit of Abrahams Co whose financial year end is 31 January.

You attended a planning meeting with the finance director and engagement partner and are now reviewing the meeting notes in order to produce the audit strategy and plan. Revenue for the year is forecast at $25 million.

During the year the company has spent $2•2 million on developing several new products. Some of these are in the early stages of development whilst others are nearing completion. The finance director has confirmed that all projects are likely to be successful and so he is intending to capitalise the full $2•2 million.

Once products have completed the development stage, Abrahams begins manufacturing them. At the year end it is anticipated that there will be significant levels of work in progress. In addition the company uses a standard costing method to value inventory; the standard costs are set when a product is first manufactured and are not usually updated.

In order to fulfil customer orders promptly, Abrahams Co has warehouses for finished goods located across Europe and Asia; approximately one third of these are third party warehouses where Abrahams just rents space.

In September a new accounting package was introduced. This is a bespoke system developed by the information technology (IT) manager. The old and new packages were not run in parallel as it was felt that this would be too onerous for the accounting team.

Two months after the system changeover the IT manager left the company; a new manager has been recruited but is not due to start work until January.

In order to fund the development of new products, Abrahams has restructured its finance and raised $1 million through issuing shares at a premium and $2•5 million through a long-term loan. There are bank covenants attached to the loan, the main one relating to a minimum level of total assets.

If these covenants are breached then the loan becomes immediately repayable. The company has a policy of revaluing land and buildings, and the finance director has announced that all land and buildings will be revalued as at the year end.

The reporting timetable for audit completion of Abrahams Co is quite short, and the finance director would like to report results even earlier this year.

Required:

Using the information provided, identify and describe FIVE audit risks and explain the auditor’s response to each risk in planning the audit of Abrahams Co. (10 marks)

Donald Co operates an airline business. The company’s year end is 31 July 2011.

You are the audit senior and you have started planning the audit. Your manager has asked you to have a meeting with the client and to identify any relevant audit risks so that the audit plan can be completed. From your meeting you ascertain the following:

In order to expand their flight network, Donald Co will need to acquire more airplanes; they have placed orders for another six planes at an estimated total cost of $20m and the company is not sure whether these planes will be received by the year end.

In addition the company has spent an estimated $15m on refurbishing their existing planes. In order to fund the expansion Donald Co has applied for a loan of $25m. It has yet to hear from the bank as to whether it will lend them the money.

The company receives bookings from travel agents as well as directly via their website. The travel agents are given a 90-day credit period to pay Donald Co, however, due to difficult trading conditions a number of the receivables are struggling to pay.

The website was launched in 2010 and has consistently encountered difficulties with customer complaints that tickets have been booked and paid for online but Donald Co has no record of them and hence has sold the seat to another customer.

Donald Co used to sell tickets via a large call centre located near to their head office. However, in May they closed it down and made the large workforce redundant.

Required:

Using the information provided, describe FIVE audit risks and explain the auditor’s response to each risk in planning the audit of Donald Co. (10 marks)

Redburn Co, a publisher and producer of books of poetry, has been a client of your firm of Chartered Certified Accountants for a number of years. The manager in overall charge of the audit has been discussing the audit plan with the audit team, of which you are a member, prior to commencement of the work.

The audit manager has informed the team, among other things, that there has been a growing interest in poetry generally and that the company has acquired a reputation for publishing poets who are still relatively unknown.

During your audit you determine:

(i) Contracts with the poets state that they are given a royalty of 10% on sales. Free copies of the books are provided to the poets and to some organisations such as copyright libraries and to others, such as reviewers and university lecturers. No royalties are given on these free copies.

(ii) The computerised customer master file contains a code indicating whether a despatch is to earn a royalty for the author. This code is shown on the sales invoice and despatch note when they are prepared.

(iii) A computerised royalties file is held, all entries therein bearing the invoice number and date.

(iv) The company keeps detailed statistics of sales made, including trends of monthly sales by type of customer, and of colleges where its books are recommended as part of course material, based on reports from sales staff.

(v) Bookshops have the right to return books which are not selling well, but about 10% of these are slightly damaged when returned. The company keeps similar records of returns as it does for sales.

A material figure in the statement of financial position of Redburn Co is the amount attributed to inventory of books.

Required:

State TWO inherent risks that may affect the inventory figure and suggest ONE control to mitigate each risk.  (4 marks)

The EuKaRe charity was established in 1960. The charity’s aim is to provide support to children from disadvantaged backgrounds who wish to take part in sports such as tennis, badminton and football.

EuKaRe has a detailed constitution which explains how the charity’s income can be spent. The constitution also notes that administration expenditure cannot exceed 10% of income in any year.

The charity’s income is derived wholly from voluntary donations. Sources of donations include:

(i) Cash collected by volunteers asking the public for donations in shopping areas,
(ii) Cheques sent to the charity’s head office,
(iii) Donations from generous individuals. Some of these donations have specific clauses attached to them indicating that the initial amount donated (capital) cannot be spent and that the income (interest) from the donation must be spent on specific activities, for example, provision of sports equipment.

The rules regarding the taxation of charities in the country EuKaRe is based are complicated, with only certain expenditure being allowable for taxation purposes and donations of capital being treated as income in some situations.

Required:

Identify areas of inherent risk in the EuKaRe charity and explain the effect of each of these risks on the audit approach. (12 marks)