ACCA AAA ^UK Syllabus D. Audit of Historical Financial Information - Business Risk - Past Papers ^{2 / 10}

You are a manager in Ryder & Co, a firm of Chartered Certified Accountants, and you have taken on the responsibility for providing support and guidance to new members of the firm. Ryder & Co has recently recruited a new audit junior, Sam Tyler, who has come across several issues in his first few months at the firm which he would like your guidance on. Sam’s comments and questions are shown below:

I know that auditors are required to assess risks of material misstatement by developing an understanding of the business risks of an audit client, but I am not clear on the relationship between business risk and risk of material misstatement. Can you explain the two types of risk, and how identifying business risk relates to risk of material misstatement? (4 marks)

Required:

For each of the issues raised, respond to the audit junior, explaining the ethical and professional matters arising from the audit junior’s comments.

You are a manager in Foo & Co, responsible for the audit of Grohl Co, a company which produces circuit boards which are sold to manufacturers of electrical equipment such as computers and mobile phones. It is the first time that you have managed this audit client, taking over from the previous audit manager, Bob Halen, last month.

The audit planning for the year ended 30 November 2012 is about to commence, and you have just received an email from Mia Vai, the audit engagement partner.

To: Audit manager
From: Mia Vai, Audit partner, Foo & Co
Subject: Grohl Co – audit planning

Hello

I am meeting with the other audit partners tomorrow to discuss forthcoming audits and related issues. I understand that you recently had a meeting with Mo Satriani, the finance director of Grohl Co. Using the information from your meeting, I would like you to prepare briefing notes for my use in which you:

(i) Evaluate the business risks faced by Grohl Co; (12 marks)

(ii) Identify and explain FOUR risks of material misstatement to be considered in planning the audit; 
(8 marks)

Thank you.

Comments made by Mo Satriani in your meeting

Business overview

Grohl Co’s principal business activity remains the production of circuit boards. One of the key materials used in production is copper wiring, all of which is imported. As a cost cutting measure, in April 2012 a contract with a new overseas supplier was signed, and all of the company’s copper wiring is now supplied under this contract. Purchases are denominated in a foreign currency, but the company does not use forward exchange contracts in relation to its imports of copper wiring.

Grohl Co has two production facilities, one of which produces goods for the export market, and the other produces goods for the domestic market. About half of its goods are exported, but the export market is suffering due to competition from cheaper producers overseas. Most domestic sales are made under contract with approximately 20 customers.

Recent developments

In early November 2012, production was halted for a week at the production facility which supplies the domestic market. A number of customers had returned goods, claiming faults in the circuit boards supplied. On inspection, it was found that the copper used in the circuit boards was corroded and therefore unsuitable for use.

The corrosion is difficult to spot as it cannot be identified by eye, and relies on electrical testing. All customers were contacted immediately and, where necessary, products recalled and replaced. The corroded copper remaining in inventory has been identified and separated from the rest of the copper.

Work has recently started on a new production line which will ensure that Grohl Co meets new regulatory requirements prohibiting the use of certain chemicals, which come into force in March 2013.

In July 2012, a loan of $30 million with an interest rate of 4% was negotiated with Grohl Co’s bank, the main purpose of the loan being to fund the capital expenditure necessary for the new production line. $2•5 million of the loan represents an overdraft which was converted into long-term finance.

Other matters

Several of Grohl Co’s executive directors and the financial controller left in October 2012, to set up a company specialising in the recycling of old electronic equipment. This new company is not considered to be in competition with Grohl Co’s operations. The directors left on good terms, and replacements for the directors have been recruited.

One of Foo & Co’s audit managers, Bob Halen, is being interviewed for the role of financial controller at Grohl Co. Bob is a good candidate for the position, as he developed good knowledge of Grohl Co’s business when he was managing the audit.

At Grohl Co’s most recent board meeting, the audit fee was discussed. The board members expressed concern over the size of the audit fee, given the company’s loss for the year. The board members would like to know whether the audit can be performed on a contingent fee basis.

Financial Information provided by Mo Satriani

Extract from draft statement of comprehensive income for the year ended 30 November 2012

The draft statement of financial position has not yet been prepared, but Mo states that the total assets of Grohl Co at 30 November 2012 are $180 million, and cash at bank is $130,000. Based on draft figures, the company’s current ratio is 1•1, and the quick ratio is 0•8.

Required:

Respond to the email from the audit partner

Jolie Co is a large company, operating in the retail industry, with a year ended 30 November 2010.

You are a manager in Jen & Co, responsible for the audit of Jolie Co, and you have recently attended a planning meeting with Mo Pitt, the finance director of the company.

As this is the first year that your firm will be acting as auditor for Jolie Co, you need to gain an understanding of the business risks facing the new client.

Notes from your meeting are as follows:

Jolie Co sells clothing, with a strategy of selling high fashion items under the JLC brand name. New ranges of clothes are introduced to stores every eight weeks

The company relies on a team of highly skilled designers to develop new  fashion ranges.

The designers must be able to anticipate and quickly respond to changes in consumer preferences.

There is a high staff turnover in the design team

Most sales are made in-store, but there is also a very popular catalogue, from which customers can place an order on-line, or over the phone.

The company has recently upgraded the computer system and improved the website, at significant cost, in order to integrate the website sales directly into the general ledger, and to provide an easier interface for customers to use when ordering and entering their credit card details.

The new on-line sales system has allowed overseas sales for the first time

The system for phone ordering has recently been outsourced.

The contract for outsourcing went out to tender and Jolie Co awarded the contract to the company offering the least cost.

The company providing the service uses an overseas phone call centre where staff costs are very low

Jolie Co has recently joined the Ethical Trading Initiative.

This is a ‘fair-trade’ initiative, which means that any products bearing the JLC brand name must have been produced in a manner which is clean and safe for employees, and minimises the environmental impact of the manufacturing process.

A significant advertising campaign promoting Jolie Co’s involvement with this initiative has recently taken place

The JLC brand name was purchased a number of years ago and is recognised at cost as an intangible asset, which is not amortised.

The brand represents 12% of the total assets recognised on the statement of financial position

The company owns numerous distribution centres, some of which operate close to residential areas.

A licence to operate the distribution centres is issued by each local government authority in which a centre is located. One of the conditions of the licence is that deliveries must only take place between 8 am and 6 pm.

The authority also monitors the noise level of each centre, and can revoke the operating licence if a certain noise limit is breached.

Two licences were revoked for a period of three months during the year

To help your business understanding, Mo Pitt has e-mailed to you extracts from the draft statement of comprehensive income, and the relevant comparative figures, which are shown below:

Required

a) Prepare briefing notes to be used at a planning meeting with your audit team, in which you evaluate the business risks facing Jolie Co to be considered when planning the final audit for the year ended 30 November 2010. (15 marks)

Professional marks will be awarded in part (a) for the format of the answer and the clarity of the evaluation. (2 marks)

(b) Using the information provided, identify and explain FIVE financial statement risks. (10 marks)

You are an audit manager in Ribi & Co, a firm of Chartered Certified Accountants.

One of your audit clients Beeski Co provides satellite broadcasting services in a rapidly growing market

In November 2005 Beeski purchased Xstatic Co, a competitor group of companies.

Significant revenue, cost and capital expenditure synergies are expected as the operations of Beeski and Xstatic are being combined into one group of companies

The following financial and operating information consolidates the results of the enlarged Beeski group:

In August 2006 Beeski purchased MTbox Co, a large cable communications provider in India, where your firm has no representation.

The financial statements of MTbox for the year ending 30 September 2006 will continue to be audited by a local firm of Chartered Certified Accountants.

MTbox’s activities have not been reflected in the above estimated results of the group.

Beeski is committed to introducing its corporate image into India

In order to sustain growth, significant costs are expected to be incurred as operations are expanded, networks upgraded and new products and services introduced

Required

Identify and describe the principal business risks for the Beeski group. (9 marks