Questions for the Case Study
Question 1: what risks are associated in the audit of the staff payroll?
Answer: The payroll balance may have calculation errors due to the increase in the number of staffs and incorporating over time increases the risks of having Material misstatement in the payroll balance.
Question 2: How should the audit team address the risk of familiarity with the client staffs?
Answer: The audit team should confirm their independence before embarking on the audit exercise and the independence forms should be signed by every staff member and the signed forms updated in the audit file to confirm that the consent of every team member sought before including them in the audit team
Question 3: How would you conduct audit for the payroll balance to determine whether the increase in the number of staff was reflected in the payroll?
Answer: We shall review staff related cost month-on-month to see if the payroll balance increased and by what percentage between the month of March and April
Question 4: What audit procedures will you conduct on inventory located in Melbourne and Perth as the balances are above the performance materiality
Answer: The audit team will obtain the stock count sheets for the period ended 30 July and perform a roll-back procedure for a sample of 15 items. This will help in getting the comfort over the accuracy of the stock balances.
Question 5: What audit risks are associated with audit of trade receivables?
Answer: Trade receivables grew by 43%. The recoverability risk exists bearing in mind that there are large amounts of sales made to the main customers. No provision has been made to the company’s books of accounts and this means that the company has not cautioned itself against occurrence of such risks.
Question 6: How should the audit team address the risk associated with non-adherence with debt covenant to ascertain that the company was performing within the limits agreed by lenders and suppliers?
Answer: The audit team should get the debt agreements, read through them and compare the company performance with the conditions stipulated in the debt agreement. Part of the analysis that should be conducted are financial ratios and agree the actuals with conditions enumerated in the debt agreements.
Question7: What risks should the auditor be concerned about from the huge inventory and decrease in demand?
Answer: Valuation of inventory will form an integral part of the audit. A valuation of inventory by comparing the carrying value and the market value of the stock will be conducted. In the event that the market prices of the tissue product are higher than the stock holding cost, the stock will be considered to be fairly stated. However, if market price is less than the inventory holding costs, then, the stock will be revalued downwards so that the realizable value is carried forward in the subsequent year.
Question 8: The audit partner has been the engagement leader for more than 15 years now. Does not this introduce familiarity threat to the audit team?
Answer: Engagement leader rotation is mostly encouraged where a client is a public limited company. However, in this case, Soft Touch Limited (STL) is not a public limited company. The board of directors have expressed confidence in the leadership provided by Kellie and that is why she has been the engagement leader for all these years. In most cased the rotation happens for the team manager and other audit team members who do the actual ground work. Issue noted during are sorted out by the engagement manager with the audit partner coming in to address issues that have significant impact on the financial statements.
Question 9: What kind of activities did MingYan execute while working as a student in STL and when was the last month he offered services for the company?
Answer: MingYan worked mostly on filling, bank reconciliations and delivering cheques to the bank. He worked in STL lastly in December 2018. Therefore, there is a low risk of self-review. This was one of the considerations that we made before picking MingYan to be part of our audit team. We understood that there was a rise of self-review but based on the fact that he was not involved in making of critical financial decisions, we considered his presence in the audit team beneficial as he understood the processes in STL.
Question 10: Does having MingYan’s friend as a receptionist in the company affect his ability to execute his role in the audit objectively?
Answer: No, the receptionist is not involved in daily book keeping in the company. An audit exercise entails a review of books of accounts and the accounting department acts as the custodian of those records. Therefore, the relationship between MingYan and the receptionist will not have an impact on the audit work he will undertake.
Question 11: What impact does offering the audit team with an opportunity to buy tissue papers at a price prescribed for the staffs has on their objectivity when carrying out audit?
Answer: There is no risk on objectivity as the amount of saving by the audit team is not material to influence their judgement during audit. In particular the saving is below the value of a gift that the firm prescribes as material and could impair the judgement of the audit team and as consequence requiring reporting to the audit partner.
Question 12: Since the interim work was done in the end of month of March and early April, how will the materiality be apportioned between the two periods.
Answer: The materiality used during the interim audit was based on profitability as at the end of February 2020. During the final audit, the materiality will be updated in line with the company’s profit and additional samples taken from the period after the year end audit.
Question 13: How does your going concern assessment on the company gets affected by the additional tax calculated by the Australian Taxation Office
Answer: The additional tax adds to the liabilities of the company and expenses as well. As a result, some of the profits that the company should report in the current accounting period will be consumed by the additional taxes. If the liability and expenses materialize, there will be doubt on the going concern as the tax liability will be a big burden to the company.
Question 14: What impact does the non-renewal of sales agreement by Coles has in the current year’s financial report?
Answer: This was a significant development after the end of the reporting period. As auditors we are required to disclose the events that took place after year end that may have a significant impact on a client’s busines. We shall disclose this in the financial statement to ensure that the users of the financial statement have information that is complete to help then in making their decisions on how to relate with the busines when making mutual business agreements.
Question 15: As the audit manager, Tim plays a key role in determining the numbers that will appear in the financial statement. However, the relationship between Tim and the CFO may jeopardize the exercise as they are close friends. How is the risk of familiarity addressed and can Tim be objective enough as he will be auditing a friend, who has significant responsibility and influence in the company?
Answer: Tim brought this to our attention before we selected him to be the audit manager for the engagement. After engaging the directors and expressing our concerns, we were assured that the CFO will not be involved in the current year’s audit as control from the management’s end. Therefore, though Tim and the CFO have a close relationship, we do not consider the relationship to have an impact on the audit as the CFO will not be involved. Perhaps this should be a concern for next year, but definitely, Tim will not be the engagement manager then. That one I can bet a 100% as Tim’s concern were noted by our audit risk team.
Question 16: How does the company minimize the risks of duplication of sales, to mitigate overreporting of profits?
Answer: The system generates sales invoices automatically. No manual input is required in raising of invoices from the system. As a result, duplication should not occur during invoicing.
Question 17: What does non-response of conformation sent to the suppliers mean for the audit?
Answer: When a negative response is sent and the creditors failure to respond, this should be interpreted to mean they agree with the numbers sent to them, and therefore, our conclusion will be that the supplier balances are not materially stated.
Question 18: A review of the financial statements disclosed that trades and other receivables went up by 43 %. However, there are no provision for bad debts identified in your books of accounts. Why is that the case?
Answer: Increase in the trade receivable was as a result of huge sales that the company made between March and June. Therefore, most of the balances in the trade receivable age below 3 months, and that is why we have not considered provision necessary at the end of June 2020.
Question 19: There is a decline both short-term and long-term provisions made between June 2019 and June 2020. Please explain why this was the case.
Answer: The decline in provisions was as a result of repayment of long-term and short-term services dues owned to staffs that were approaching retirement in the next two years. The staff decided to take an early retirement instead of working from home as suggested by the management.
Question 20: How will you treat the misstatement of long service and suppliers’ invoice?
Answer: Since these balances are below our performance materiality, no audit journals will be proposed. However, we shall include the balances in the final report issued to the client to bring the misstatement to the their attention.
