ACCA AAA ^INT Syllabus D. Audit of Historical Financial Information - Inventory - Past Papers ^{1 / 41}

You are the manager responsible for the audit of Osier Co, a jewellery manufacturer and retailer. The final audit for the year ended 31 March 2017 is nearing completion and you are reviewing the audit working papers. The draft financial statements recognise total assets of $1,919 million (2016 – $1,889 million), revenue of $1,052 million (2016 – $997 million) and profit before tax of $107 million (2016 – $110 million). Three issues from the audit working papers are summarised below:

(a) Cost of inventory
Inventory costs include all purchase costs and the costs of conversion of raw materials into finished goods. Conversion costs include direct labour costs and an allocation of production overheads. Direct labour costs are calculated based on the average production time per unit of inventory, which is estimated by the production manager, multiplied by the estimated labour cost per hour, which is calculated using the forecast annual wages of production staff divided by the annual scheduled hours of production. Production overheads are all fixed and are allocated based upon the forecast annual units of production. At the year end inventory was valued at $21 million (2016 – $20 million). (7 marks)

Required:
Comment on the matters to be considered, and explain the audit evidence you should expect to find during your file review in respect of each of the issues described above.

Note: The split of the mark allocation is shown against each of the issues above. You are not required to discuss any potential implications for the auditor’s report.

The schedule of proposed adjustments to uncorrected misstatements included in Bradley Co’s audit working papers is shown below, including notes to explain each matter included in the schedule. The audit partner is holding a meeting with management tomorrow, at which the uncorrected misstatements will be discussed.

3. The estimate relates to slow-moving inventory in respect of a particular type of steel alloy for which demand has fallen. Management has already recognised a provision of $35,000, which is considered insufficient by the auditor.

Required:
(i) Explain the matters which should be discussed with management in relation to each of the uncorrected misstatements; and (9 marks)

(ii) Assuming that management does not adjust the misstatements, justify an appropriate audit opinion and explain the impact on the auditor’s report. (4 marks)

Willow Co is a print supplier to businesses, printing catalogues, leaflets, training manuals and stationery to order. It specialises in using 100% recycled paper in its printing, a fact which is promoted heavily in its advertising.

You are a senior audit manager in Bark & Co, and you have just been placed in charge of the audit of Willow Co. The audit for the year ended 31 August 2011 is nearing completion, and the audit engagement partner, Jasmine Berry, has sent you an email:

To: Audit manager
From: Jasmine Berry, Audit partner
Subject: Audit completion and other issues – Willow Co

Hello

The manager previously assigned to the audit of Willow Co has been moved to another urgent assignment, so thank you for stepping in to take on the manager’s role this late in the audit. The audit report is due to be issued in two weeks’ time, and the audit senior has prepared a summary of matters for your consideration.

I have been asked to attend a meeting with the audit committee of Willow Co tomorrow, so I need you to update me on how the audit has progressed. I am asking you to prepare briefing notes for my use in which you:

Assess the audit implications of the THREE issues related to audit work raised by the audit senior. Your assessment should consider the sufficiency of evidence obtained, explain any adjustments that may be necessary to the financial statements, and describe the impact on the audit report if these adjustments are not made. You should also recommend any further audit procedures necessary. (15 marks)

Thanks

Summary of issues for manager’s attention, prepared by audit senior

Materiality has been determined as follows:

$800,000 for assets and liabilities
$250,000 for income and expenses

Issues related to audit work performed:

(i) Audit work on inventory

Audit procedures performed at the inventory count indicated that printed inventory items with a value of $130,000 were potentially obsolete. These items were mainly out of date training manuals. The finance director, Cherry Laurel, has not written off this inventory as she argues that the paper on which the items are printed can be recycled and used again in future printing orders.

However, the items appear not to be recyclable as they are coated in plastic. The junior who performed the audit work on inventory has requested a written representation from management to confirm that the items can be recycled and no further procedures relevant to these items have been performed.

(ii) Audit work on provisions

Willow Co is involved in a court case with a competitor, Aspen Co, which alleges that a design used in Willow Co’s printed material copies one of Aspen Co’s designs which are protected under copyright. Our evidence obtained is a verbal confirmation from Willow Co’s lawyers that a claim of $125,000 has been made against Willow Co, which is probable to be paid.

Cherry Laurel has not made a provision, arguing that it is immaterial. Cherry refused our request to ask the lawyers to confirm their opinion on the matter in writing, saying it is not worth bothering the lawyers again on such a trivial matter.

(iii) Audit work on current assets

Willow Co made a loan of $6,000 to Cherry Laurel, the finance director, on 30 June 2011. The amount is recognised as a current asset. The loan carries an interest rate of 4% which we have confirmed to be the market rate for short-term loans and we have concluded that the loan is an arm’s length transaction.

Cherry has provided written confirmation that she intends to repay the loan by 31 March 2012. The only other audit work performed was to agree the cash payment to the cash book. Details of the loan made to Cherry have not been separately disclosed in the financial statements.

Other issues for your attention:

Property revaluations

Willow Co currently adopts an accounting policy of recognising properties at cost. During the audit of non-current assets Willow Co’s property manager said that the company is considering a change of accounting policy so that properties would be recognised at fair value from 1 January 2012.

Non-current asset register

The audit of non-current assets was delayed by a week. We had asked for the non-current asset register reconciliation to be completed by the client prior to commencement of our audit procedures on non-current assets, but it seems that the person responsible for the reconciliation went on holiday having forgotten to prepare the reconciliation. This happened on last year’s audit as well, and the issue was discussed with the audit committee at that time.

Procurement procedures

We found during our testing of trade payables that an approved supplier list is not maintained, and invoices received are not always matched back to goods received notes. This was mentioned to the procurement manager, who said that suppliers are switched fairly often, depending on which supplier is the cheapest, so it would be difficult to maintain an up-to-date approved supplier list.

Financial controller

Mia Fern, Willow Co’s financial controller, owns a holiday home overseas. It appears that she offered the audit team free use of the holiday home for three weeks after the audit, as a reward for the team’s hard work. She also bought lunch for the audit team on most days.

Required:

Respond to the partner’s email.

You are a senior audit manager in Suki & Co, a firm of Chartered Certified Accountants. This morning you have been re-assigned to the audit of Bill Co, a long-standing audit client of your firm, as the manager previously assigned to the client has been taken ill.

Bill Co has a year ending 30 June 2011, and the audit planning has been largely completed by the previously assigned audit manager, Tara Lafayette, who had been recruited by your firm four months ago.

Bill Co is a property development company, specialising in the regeneration and refurbishment of old industrial buildings, which are sold for commercial or residential use. All property developments are performed under specifically negotiated fixed-price contracts. The company was founded 35 years ago by two brothers, Alex and Ben Bradley, who own the majority of the company’s share capital.

Alex and Ben are nearing retirement age, and are planning to sell the company within the next two years. The forecast revenue for the year ending 30 June 2011 is $10•8 million, and the forecast profit before tax is $2•5 million. The forecast statement of financial position recognises total assets of $95 million.

You have just received the following email from the audit engagement partner:

To: Audit manager
From: Audit partner
Regarding: Bill Co – audit planning

Hello

Thanks for taking on the role of audit manager for the forthcoming audit of Bill Co.

(i) I have just received some information on two significant issues that have arisen over the last week, from Sam Compton, the company’s finance director. This information is provided in attachment 1.

I am asking you to prepare briefing notes, for my use, in which you explain the matters that should be considered in relation to the treatment of these two issues in the financial statements, and also explain the financial statement risks relating to them. I also want you to recommend the planned audit procedures that should be performed in order to address those risks. (16 marks)

(ii) In addition, please critically evaluate the planning that has been completed by the previously assigned audit manager. Relevant details are provided in attachment 2, which contains notes made by her, and placed on the current year audit file. Make sure you include discussion of any ethical matters arising from the notes, and recommend any actions you think necessary. (11 marks)

Thanks.

Attachment 1: Information from Sam Compton, finance director of Bill Co

In the last week, two significant issues have arisen at Bill Co. The first issue concerns a major contract involving the development of an old riverside warehouse into a conference centre in Bridgetown. An architect working on the development has discovered that the property will need significant additional structural improvements, the extra cost of which is estimated to be $350,000.

The contract was originally forecast to make a profit of $200,000. The development is currently about one third complete, and will take a further 15 months to finish, including this additional construction work.

The customer has been told that the completion of the contract will be delayed by around two months. However, the contract price is fixed, and so the additional costs must be
covered by Bill Co.

The second issue concerns one of Bill Co’s specialist divisions, which trades under the name ‘Treasured Homes’ and which deals exclusively in the redevelopment of non-industrial historic buildings such as castles and forts.

These buildings are usually acquired as uninhabitable ruins, and are then developed into luxury residences for wealthy individuals. The management of Bill Co decided last week to sell this division, as although it is profitable, it generates a lower margin than other business divisions.

‘Treasured Homes’ operates separately from the rest of the business, and generates approximately 15% of the total revenue of the company. In a board minute dated  1 June 2011, it was noted that ‘interest has already been expressed in this division from a potential buyer, and it is hoped that sale negotiations will soon commence, leading to sale in August 2011.

There is a specific office building and some other tangible assets that will be sold as part of the deal. These assets are recorded at  $7•6 million in the financial statements. No redundancies will be necessary as employees’ contracts will transfer to the new owners.’

Attachment 2:

Planning Summary: Bill Co, year ending 30 June 2011, prepared by Tara Lafayette, manager previously assigned to the audit

The planning for the forthcoming audit is almost complete. Time has been saved by not carrying out procedures considered unnecessary for this long-standing audit client. Forecast accounts have been obtained and placed on file, and discussions held with management concerning business developments during the year.

Analytical procedures have been performed on the statement of comprehensive income, but not on the statement of financial position, as there did not appear to be any significant movements in assets or liabilities since last year.

Management confirmed that there have been no changes to accounting systems and controls in the financial year. For this reason we do not need to carry out walk-through tests or review our documentation of the systems and controls.

Management also confirmed that there have been no changes to business operations, other than the potential sale of ‘Treasured Homes’. All divisions are operating normally, generating sufficient profit and cash. For this reason, the business risk of Bill Co is assessed as low, and no further comments or discussions about business operations have been placed on file.

The matter that will demand the most audit work is the valuation of properties currently under development, especially the determination of the percentage completion of each development at the reporting date. Historically, we have engaged a property valuation expert to provide a report on this area.

However, Bill Co has recently employed a newly qualified architect, who will be happy to provide us with evidence concerning the stage of completion of each property development contract at the year end. Using this person to produce a report on all properties being developed will save time and costs.

Bill Co has recently completed the development of a luxury new office building in Newtown. Several of the office units are empty, and the management of Bill Co has offered the office space to our firm for a nominal rent of $100 per year.

Required:

Respond to the partner’s email.

You have been asked to carry out an investigation by the management of Xzibit Co. One of the company’s subsidiaries, Efex Engineering Co, has been making losses for the past year. Xzibit’s management is concerned about the accuracy of Efex Engineering’s most recent quarter’s management accounts.

The summarised income statements for the last three quarters are as follows:

Xzibit’s management board believes that the high material consumption as a percentage of revenue for the quarter to 30 June 2006 is due to one or more of the following factors:

(1) under-counting or under-valuation of closing inventory;
 (2) excessive consumption or wastage of materials;
 (3) material being stolen by employees or other individuals.

Efex Engineering has a small number of large customers and manufactures its products to each customer’s specification. The selling price of the product is determined by:

(1) estimating the cost of materials;
 (2) estimating the labour cost;
 (3) adding a mark-up to cover overheads and provide a normal profit.

The estimated costs are not compared with actual costs. Although it is possible to analyse purchase invoices for materials between customers’ orders this analysis has not been done.

A physical inventory count is carried out at the end of each quarter. Items of inventory are entered on stocksheets and valued manually. The company does not maintain perpetual inventory records and a full physical count is to be carried out at the financial year end, 30 September 2006.

The direct labour cost included in the inventory valuation is small and should be assumed to be constant at the end of each quarter. Historically, the cost of materials consumed has been about 70% of revenue.

The management accounts to 31 March 2006 are to be assumed to be correct.

Required:

(a) (i) Explain the matters you should consider to determine whether closing inventory at 30 June 2006 is undervalued; and

(ii) Describe the tests you should plan to perform to quantify the amount of any undervaluation. (8 marks)

(b) (i) Identify and explain the possible reasons for the apparent high materials consumption in the quarter ended 30 June 2006; and

(ii) Describe the tests you should plan to perform to determine whether materials consumption, as shown in the management accounts, is correct. (7 marks)