Question

You are an audit supervisor of Pure & Co and are planning the audit of your client, Star Co. Ltd which manufactures cleaning products. Its year end was 31 July 20X6 and the draft profit before tax is $33·6 million. You are supervising a large audit team for the first time and will have specific responsibility for supervising and reviewing the work of the audit assistants in your team.
Pure Co purchases most of its raw materials from suppliers in Africa and these goods are shipped directly to the company’s warehouse and the goods are usually in transit for up to three weeks. The company has incurred $1·4 million of expenditure on developing a new range of cleaning products which are due to be launched into the market place in November 20X6.
In September 20X5, Star Co. Ltd also invested $0·9 million in a complex piece of plant and machinery as part of the development process. The full amount has been capitalised and this cost includes the purchase price, installation costs and training costs.
This year, the bonus scheme for senior management and directors has been changed so that rather than focusing on profits, it is instead based on the value of year-end total assets. In previous years an allowance for receivables, made up of specific balances, which equaled almost 2% of trade receivables was maintained. However, the finance director feels that this is excessive and unnecessary and has therefore not included it for 20X6 and has credited the opening balance to the profit or loss account.
A new general ledger system was introduced in May 20X6; the finance director has stated that the data was transferred and the old and new systems were run in parallel until the end of August 20X6. As a result of the additional workload on the finance team, a number of control account reconciliations were not completed as at 31 July 20X6, including the bank reconciliation.
The finance director is comfortable with this as these reconciliations were completed successfully for both June and August 20X6. In addition, the year-end close down of the purchase ledger was undertaken on 8 August 20X6.
Required: (b) Describe any SIX audit risks, and explain the auditor’s response to each risk, in planning the audit of Star Co. Ltd.

Answer 1

Audit is an independent examination of the financial statements of the company to ensure that financial statements are free from mis-statements.

There are so many risk involved while the financial statements. Auditor is required to check each and every risk accordingly.

The six Audit risks that are shown in Star Co. financials, and the steps required to be taken by the auditor during planning are:-

1. Risk:- The company has purchases most of its material from African company and all the items has been directly shipped in the company warehouse. The company has not maintained any checkpoint for the checking the quality and quantity of the material imported. It takes a 3 weeks journey to reach there and there is possibility of being theft or degradation of material.

Auditor responses:- The auditor should properly check the bill of entry of each ship and recheck the quantity from the Purchasing order. The auditor should visit the company warehouse and perform inventory counting at specified date.

2. Risk:- The company has invest $1.4 million in developing new product. The product is still on developing stage and should be expenses off instead of capitalised.

Auditor responses:- The auditor should ensure that the expenditute done by company should be booked as an expense and do not booked as fixed asset.

3. Risk:- The company has purchased the machiney at $0.9 million. The company has capitalised training cost also which doesnt form part of the capitalization.

Auditor responses:- The auditor should check why company has capitalizing the training cost and insist company to book it as expense instead of capitalized. The Auditor should also check completion certificate of the Asset.

4. Risk:- The bonus scheme of the senior management and directors has been changed from the profit oriented to Asset value oriented. This leads to gain extra by management through comapany capitalization instead of focussing on profit increment.

Auditor responses:- The auditor should check why company has taking such decision and wheather such decision has been passed by the shareholders of the company. Is senior management using its power for their personal gains?

5. Risk:- Previously, company has maintaining the balance of 2% of the doubtful debts over receivables. but form the current year, management has reversed it and increase profit. The Risk that company tries to increase profit through reversed the provisions.

Auditor responses:- The auditor should take the proper justification from the company, why company is doing this? The auditor should re-evaluate the provisional liability and told to the senior most management to consider this. If they didn't consider and the liability is material then report in their Audit report and take necessary actions.

6. Risk:- New general ledger system introduced which works parallel to old one. This increase workload over previous staff and result in incompletion of work as on 31st July. The risk of incompleteness also attached with it.

Auditor responses:- The auditor should perform the depth checking of the accounts form May 2006 to August 2006 data, to ensure the data has been properly completed and no material item has been left.