Question

For the current year audit, Blue Cow’s draft Trading Account shows the following figures:

Sales $100,000

Cost of Sales 69,000

Gross Profit $31,000

Basic analytical procedures therefore show a GP% of 31% this year which is higher than the normal range of 24% - 26%. You intend to enquire of management as to the reasons for the current year increase, before undertaking further audit work to investigate potential misstatements.

Required:

a) Identify one possible explanation that you would accept from management that would satisfy you that the above GP% increase was not due to potential misstatements.

b) Assume that management has no satisfactory explanations and that further audit investigation reveals Cost of Sales is misstated due to potential misstatements in the closing inventory figure:

i) Calculate by how much closing inventory may be overstated.

ii) State and explain whether you consider this to be a material misstatement.

iii) Identify which two audit assertions you would focus on and explain how these relate to investigating the suspected overstatement of closing inventory.

Answer 1

a):possible explanation for the increase in gross profit

1. decrease in the direct cost compared to previous years and or industries
2. selling price increased compared with previous years or industries

b):

1) calculation of inventory may be overstated by

normal gross profit ratio = 24% to 26%

normal gross profit could be = when 24% = 24000 m when gross profit is 26% = 26000

so gross profit misstated by 5000 to 7000

which closing inventory value could be misstated by around $ 5000 to $ 7000

2) it is consider to be material as the amount misstated is more than 0.5% of the gross profit

if gross profit is $24000 then percent = (31000-24000)/24000= 29.17%

if gross profit is $26000 then percent = (31000-26000)/26000= 19.23%

as the misstatement in the gross profit is morethan 0.5% consider to be material

3)

two assertion that should be focused on to investigate is

completeness : whether the balances in the inventory is completely recorded in the statement and trace the documents

accuracy valuation and allocation : using the assertion calculate the correct amount and ensure correct valued to inventory according to the framework