Auditing Assignment Preparing Audit Procedures For Business Transactions

Question

Task:
The questions to be answered in the auditing assignment are:

Q1 - Week 6
As the auditor of Komsu Air Limited (KAL) that manufactures and installs large commercial airconditioning systems. KAL typically has two or three large contracts (ranging from $6 million to $10 million each) in progress at any one time. The contracts usually take up to six months to complete, although unexpected on-site difficulties can result in lengthy delays in completion (of up to 12 months). KAL finances its operations with a mixture of equity, long-term debt (secured by fixed assets) and short-term bank loans.

It is now May 2017 and your planning of the audit of KAL for the year ended 30 June 2017 is nearing completion. You have met with the management of KAL and, from those discussions and a review of the preliminary information provided by KAL, you have identified several issues that may have implications for the company’s ability to continue as a going concern. The relevant issues are as follows:

• Competition in the industry is becoming more intense, with some customers now installing their own systems.
• KAL’s bank has requested cash flow forecasts for the coming year to support the short-term loans. It has indicated that it may need to withdraw funding or restructure debt if the forecasts are not adequate. The review of work-in-progress indicates that all the contracts in progress at year end are due for completion within six months of the balance date. There are no new contracts in place for the coming year, although management has indicated that there are orders currently being negotiated. The nature of the business is such that sales will fluctuate considerably from year to year depending on the timing of one or two large contracts.
• Assets consist chiefly of plant and equipment, some of which is specialised to the industry. Debtors are significant, but recoverability is not considered an issue as the ongoing projects are with reputable customers and management is not aware of any problems. Creditor balances are at normal levels, and the company is in a positive working capital position.
• Included in provisions is a large provision for warranty for one of KAL’s jobs completed at a hotel two years ago. It appears that the air-conditioning system is still not working and the hotel is now requesting a substantial refund of the contract price.

Required:
Explain whether you believe the area of going concern should be assessed as high risk and mitigating factors for KAL’s audit for the year ended 30 June 2017.

Q2- Week 7
Wares king supplies custom-fitted curtains and blinds to retail customers. It has recently expanded to offer a wide variety of home decorating products through its six stores across the state. After some initial problems with stock control it installed a new automated inventory system in April this year. The system replaced another automated system that had been modified so often over the years that the auditor had advised Wares’s management that they did not regard it as reliable. That is, the auditor was unable to rely on the old system sufficiently to assess control risk for inventory as anything less than high.

Required:

1. Explain the normal process an auditor would expect to find in the client’s systems governing changes to computer programs. Why is an auditor concerned about program changes?
2. Wares kings’ financial year-end is 31 December. Does the auditor need to obtain evidence about the performance of the inventory control system from every month in the year or from a sample of months? Explain.
3. If the auditor conducts test of the inventory controls at an interim date, is it appropriate to conclude that the controls also relate to the end of period date? Why?

Q3- Week 8
You are the audit manager at KPMG & Coopers a medium-sized audit firm undertaking the audit for the year ended 30 June 2018 of Vesta Tech Ltd, an electronic component manufacturer located in Sydney. During the planning stage of the audit you discovered that one of Vesta Tech Ltd’s major suppliers went bankrupt one month ago, causing major product shortages. To overcome the problem, Jonathon Marshall, the husband of the finance director, Nimat Marshall provided electronic components to Vesta Tech Ltd through his private company. There is no formal agreement in place with Jonathon Marshall, however, the goods are being provided at competitive prices. You are concerned about the electronic components that Jonathon Marshall’s company is supplying, because his products are new to the market and you have heard some of Vesta Tech Ltd’s staff complaining that they are of poor quality.

The board has informed you that although sales have been strong this year, Vesta Tech Ltd has suffered significant cash flow problems because a major debtor, Mimosa Ltd, is experiencing financial difficulties. As a result, Mimosa Ltd is taking well over 120 days to pay outstanding amounts, despite Mimosa Ltd’s terms of trade being payment within 30 days. Mimosa Ltd makes up 40 per cent of Vesta Tech Ltd’s sales and the board has been reluctant to take any action that might adversely affect those sales. As a result, Vesta Tech Ltd has had to increase its dependency on its line of credit, and this has caused it to temporarily breach the debt to equity ratio required in its loan covenant with WestPac Bank Ltd.

The management of CGL is currently reviewing the structure of its audit committee to ensure that it complies with the requirements of the ASX Corporate Governance Principles and Recommendations.

However, the board is confused by the reference in the ASX Corporate Governance Principles and Recommendations to both independent directors and non-executive directors, as they thought that they were the same thing. As a result, they have sought your advice concerning the structure of their audit committee.

Required:

1. Identify two key account balances at risk of material misstatement.
2. For each account balance identify the key assertion at risk.
3. Explain why the account balance and assertion are at risk.
4. Describe one (1) substantive test of detail that you would undertake for each account to address the assertion and risk identified.

Q4 - Week 9

1. What are key audit matters? How do these affect the format of the audit report?
2. Stewart Jones is reviewing the results of the subsequent events audit procedures. Stewart is writing a report for his audit partner based on these results and will be attending a meeting tomorrow with the partner and representatives of the company to discuss them. The issue will be whether the financial report should be amended, or additional notes included for these subsequent events.

Many of the items are not material and Stewart will recommend that no action be taken with respect to these. However, there are several items that Stewart believes are material and should be discussed at the meeting. These are as follows.

1. The board is planning to issue shares in a private placement on 15 August.
2. The share issue is to fund the purchase of a 60 per cent stake in another company. The negotiations are in the final stages and although the contract is not yet signed it will be signed by 15 August.
3. A writ was lodged in the Supreme Court in the week after year-end claiming damages for illness allegedly caused by chemicals used at a subsidiary company’s manufacturing plant in the 1990s. This is the tenth such writ lodged, and the client has denied responsibility in all cases because it was unreasonable to believe at that time that these chemicals had adverse health effects. The claimant has new scientific evidence that counters this defence.
4. The review of subsequent cash receipts has revealed that several of the trade receivables that were considered doubtful have now been paid. However, the audit procedures have shown that a large debtor that was considered safe at 30 June was unexpectedly declared bankrupt on 20 July.

The year-end for the company is 30 June and the audit report is due to be signed on 20 August.

Required:
For each of the items above, explain what type of subsequent event it is and the appropriate treatment of the item in the financial report.

Q5- Week 10
You are the audit partner at Parkville & Associates, a mid-tier audit firm. You are responsible for the audits of the following four independent entities for the year ended 30 June 2018:

1. Human Help Ltd is a non-profit entity. You have discovered that it has not kept substantiating vouchers or receipts for more than 55 per cent of its expenses, excluding salaries and allowances
2. JJ King Ltd is a building contractor with a varying workload. In order to compensate for the irregularity of its contracted building projects, JJ King also purchases large vacant blocks of land that it later subdivides for the construction of houses and units. JJ King then sells these on its own account. Your analysis strongly suggests that the apportionment of costs to houses and units sold has been kept low to boost profits. In your opinion, this has resulted in the overvaluation of the unsold properties. The directors of the company do not agree and hold to their view that the stock of properties is correctly valued
3. You have completed the audit of Grand Resort Ltd (Grand Resort) for the year ended 30 June 2015. The audit partner suggested that the value of properties on the Gold Coast were overstated by $16 million, a figure which was twice the level of materiality set for the audit. As a result of discussions with the audit committee, the CEO of Grand Resort agreed to revise the valuations downward by $10 million. All other issues were resolved to the satisfaction of the audit partner, resulting in an overall misstatement of the financial report of $6 million. The audit partner is now considering the effect of the misstatement on the auditor’s report.
4. Grand Event Ltd arranges for popular overseas entertainment artists to perform in Australia. The band Eclipse was booked by Grand Event to play in major cities across the country. Grand Event’s written contract required the company to pay the band in US dollars but, in order to reduce costs, it did not hedge the amounts. Subsequent to year end, the Australian dollar fell against the US dollar and a substantial loss relating to the band’s tour was predicted. The management of Grand Event tried unsuccessfully to renegotiate the band’s contract and has been unable to obtain finance to cover the expected shortfall. Grand Event has now cancelled the tour and expects a substantial claim from Eclipse. It is clear to you, as the auditor, that Grand Event does not have the income, cash or other assets to sustain such a loss.

Required:
Assuming no amendments have been made, identify and explain the type of auditor’s opinion required for each issue outlined above.

Answer

Week 6
Going-concern concept examined in this auditing assignment:

The going-concern concept is an accounting principle that states the financial ability of an organization to continue its business operations in the present as well as the future (Geoffrey et al 2016). Every organization focuses on earning maximum profits through proper utilization of its resources for the accomplishment of its pre-determined long term and short term goals and objectives. In the given case of KAL, it was observed that the company is currently facing various issues and these might impact the wellbeing of the same if they are left unresolved. The indicators of the afore-named company’s measure of going-concern along with the relevant factors that can help in mitigating these issues are provided and discussed as follows:

Week 7

1. The management of a company is responsible for making changes to computer systems. These changes can only be made after a discussion with the concerned authorities and the management must document the same in for future reference. Documenting this information will enable the auditor to learn more about why these changes are made to computer programs and upon whose approval. Installing a fresh computer system will require approval from the Board while other changes require approval from the senior management of the company. The auditor would also expect to find other information concerning the changes to computer programs such as test data, the changes, employees involved, segregation of responsibilities, etc.

   Changes to computer programs may introduce multiple errors to computer systems and this is also why auditors are more concerned about these changes.

2. All the purchases and sales transactions are recorded in the financials of an organization. These financials are prepared by an organization every year. Installing a new computer program or making any changes to the existing computer programs is a very critical decision and this must be done after receiving approval from the concerned authorities. There are probabilities for the errors to take place and a contrast between the results for both the periods i.e. before and after the changes to computer programs to take place. It is the responsibility of the auditor to check whether the controls are required to be tested separately for both the periods or not. There must be proper evidence for both the periods and the evidence for every month is not required.
3. The appropriateness of the provisional testing can be conformed if only this testing was conducted after the changes were made to computer programs. This means if the interim testing was conducted prior to the installation of a new inventory system, then the appropriateness of this testing will remain doubtful. In the given case, all the transactions for the year were recorded using the previous inventory system. Therefore, it is recommended that the purchase and sales accounts of the company must be tested including sufficient evidence from the pre-April dates.

Week 8

1. The two accounts that are prone to material misstatement risk are sales account and debtors accounts.
2. Debtors account- Valuation, presentation, and disclosure seems inappropriate in the company’s debtor account.

   Sales account- Completeness, and valuation of sales seem affected.

3. Sales:
   In the given case, completeness, and valuation of sales seems impacted as the company is unable to realize its dues from a customer who is currently facing a huge financial crisis. As per generally accepted accounting principles (GAAP), such sales will not be recorded until and unless the same is realized.

   Debtors:
   If the debtor is facing a huge financial crisis, then the chances of realization of dues from him become obsolete. Therefore, Valuation, presentation, and disclosure seem inappropriate in the company’s debtor account.

4. The following tests should be conducted:
   1. Discussion with senior management on remedial measures.
   2. The financial reports of the defaulting debtors must be accessed and investigated.
   3. An independent confirmation must be obtained from the defaulting debtors.
   4. Verification of invoices prior to the approval of the auditor’s report.

Week 9
Key Audit Matters (KAM)
KAM refers to those audit matters that hold a huge significance in the professional judgment of an auditor. Not all audit matters are labeled as “key”. Only those matters that are of utmost importance are termed as key audit matters by an auditor in his professional judgment (Anderson 2010).

The auditor must disclose the key audit matters in his audit report and must also discuss these matters in detail addressing as to why these matters were considered significant in his opinion, and how these matters were addressed in his audit function. The auditor must also provide references along with relevant disclosures (Gay & Simnett 2018).

KAMs are required to be disclosed right after the segment dedicated to “basis for opinion” and before the segment dedicated to “management responsibility”.

Issue 1: There is a writ lodged against the company in the Supreme Court in the 1990s claiming damages for an illness that is allegedly caused as a result of the chemicals that are used at its subsidiary’s manufacturing plant. There are 9 other writs filed against the company prior to the afore-mentioned writ. The company has continuously denied responsibility in all cases. However, the claimant claims of having new scientific evidence to support his claims. The chances for the company to win in this case need to be evaluated. Losing this case would mean that the company will be required to pay huge amounts as compensation and this will also impact its goodwill and perpetual succession. Therefore, all these points should also be discussed in the audit report.

Issue 2: In this case, the auditor will need to check if it’s a bogus receipt or not. There are higher probabilities that the debtors’ balances are manipulated by reporting a bogus receipt in their respective accounts. The auditor should also check if these receipts have a significant impact on the financial reports of the company as of June 30th. If the auditor learns about the fact that these receipts do have a significant impact on the company’s going-concern principle, then he should adjust the receipts accordingly.

Week 10

References
Anderson, A.W. 2010, A practical approach to understanding audit risk, Account-Ability Plus

Gay, G., & Simnett, R 2018, Auditing and Assurance Service in Australia, McGraw-Hill Education (Australia)

Geoffrey D. B, Joleen K, K. Kelli S. and David A 2016, Attracting Applicants for In-House and Outsourced Internal Audit Positions: Views from External Auditors. Auditing assignment Accounting Horizons vol. 30, no. 1, pp. 143-156

Murphy, G., 2015, A vision for the future: by using the most current technology and keeping their skills up to date, management accountants can enhance their careers and their organizations. Strategic Finance, vol. 97, no. 4, pp.62-64.