Question

Apricot is an information technology (IT) manufacturing company which has been dealing in various IT equipment over 70 years. It operates from one central site which includes the production facility, warehouse and administration offices.

You are an audit senior in Juit Company, and you are commencing the audit planning of Apricot Company for the year ending 31 April 2019.

Apricot Company sells all of it IT equipment to multinational clients, with 75% being sold to a multi-million IT dealer. The company has a one-year contract to be the sole supplier of IT equipment. In order to secure the contract, the company reduced prices and offered 100 days credit period, while its normal credit period is 28 days, which is an equivalent of month.

Currently, Apricot Company has strategically reduced the level of products directly manufactured and rather started to import significant amount of its IT equipment from India. Nearly 65% of the IT equipment is imported and 35% manufactured. Purchase orders for imports are made five months in advance and goods can be in transit for up to three months. Apricot Company accounts for the inventory when it receives the goods.

An assessment show that Apricot Company has an equipment manufacturing plant which is now redundant and also assessed to have minimal scrap value.

To avoid the disruption of a year-end inventory count, Apricot Company has this year introduced a continuous inventory counting system. Apricot Company divided the warehouse into 12 areas, and each of these are to be counted once within the year. At the year-end, it is proposed that the inventory will be based on the underlining records. Traditionally, Apricot Company has maintained an inventory allowance based on 2% of the inventory value, but management feels that as inventory is being reviewed more regularly, it no longer needs this allowance.

In January 2019 Apricot Company had a dispute with its finance director (FD) and he was forced to immediately leave the firm. In his place, the company has asked the financial controller to take over the role temporarily, while they recruit a permanent replacement. The old FD has notified Apricot that he has intentions of suing for unfair dismissal. The company is not proposing to make any provision or disclosure for this, as they are confident the claim has no merit.

You are required to:

Explain the audit risks identified at the planning stage of the audit of Apricot Company.

Discuss the importance of assessing risks at the planning stage of an audit.

Describe THREE substantive procedures the auditor of Apricot Company should perform at the year-end in confirming each of the following:
(1) The valuation of inventory
(2) The completeness of provisions of contingent liabilities.

Answer 1

Solution-I Being a professional, First of all I define the meaning of Audit Risk Audit Risk is the risk that an auditor expresses an inappropriate opinion the financial statements. For Example:- on an Issuing unqualified report where a qualification is reasonably justified. Failing to disclose a significant matter in the final audit report etc. After consideration of above mentioned data of Apricot Company, following risk is identified:-

1. The company increase the credit period to 100 days from 28 days and reduce the price. Here my risk is related to the approval authority, who extend the such credit period and the amount of price reduction. 2. At which price products is imports from India, Whether these prices approved or not. 3. Whether Import price is less than In-house production or not. 4. What is the control over Goods-In-Transit and who is the responsible authority. 5. Whether company liable to pay the cost of Insurance of Goods-In-Transit. 6. At what basis Company assessed the scrap value of the redudant plant.

7. What is the probability of pay compansation to Finance Director (FD). Whether it should be shown in audit report as contingent liability 8. What is authenticity of "continuous inventory counting system". 9. What is the basis of dividing the warehouses in 12 area. Additionaly:- The Auditor (An Auditor in Juit Company) who conduct the Audit of IT & manufacturing organisation, may not have proper understanding of Operations of Apricot company. It is also a risk that associated with the audit. It can be mitigated through deep study of culture and operations of the company.

Solution-II It is vitally important for auditors to assess engagement risks at the planning stage. Following is the importance of assessing risks at the planning stage of an audit. 1. This will ensure that attention is focused early on the areas most likely to cause material misstatements. 2. A thorough risk assessment will also help the auditor to fully understand the entity, which is vital for an effective audit. 3. Any unusual transactions or balances would also be identified early, so that these could be addressed in a timely manner.

4. In addition, as most auditors adopt a risks based audit approach then these risks need to be assessed early in order for the audit strategy and detailed work programmes to be developed. 5. Assessing risks early should also result in an efficient audit. The team will only focus their time and effort on key areas as opposed to balances or transactions that might be immaterial or unlikely to contain errors. 6. In addition assessing risk early should ensure that the most appropriate team is selected with more experienced staff allocated to higher risk audits and high risk balances

7. A thorough risk analysis should ultimately reduce the risk of an inappropriate audit opinion being given. The audit would have focused on the main risk areas and hence all material misstatements should have been identified, resulting in the correct opinion being given. 8. It enable the auditor to have a good understanding of the risks of fraud, money laundering, etc. Solution-III I will perform the following Substantive procedures at the year-end in confirming

The valuation of inventory. 1. Identify the basis of dividing the Warehouses in 12 areas. Make physical counts of different items on test basis. If there are high value inventory, An auditor should spent extra time to such items. 2. Reconcile the inventory count to the general ledger:- They will trace the valuation compiled from the physical inventory count to the company's general ledger, to verify that the counted balance was carried forward into the company's accounting records. 3. Test inventory in transit:- Goods- In- Transit received after 3 months. Auditor should check this goods through reviewing transfer documentation, Letter of credit (If available), Bank gurantee (If available) any other document available.

B. The completeness of provisions of contingent liabilities. 1. Auditor should assess the probablity of arising of such liability 2. After completion of above step-1, Estimate the amount which can be paid to the Finance Director (FD). Such amount identified with discussion of company's advocate. 3. After completion of above steps, Auditor should give his final observation in final "Audit Report". Such amount should mention in the financial statement seperatly under footnote of "Contingent Liabilty".
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Answer 2

1. The auditor assesses following risk involved in audit at planning stage-

a. Inventory record may not mactch with actual inventory as the Company is not performing the full inventory count at year end.

b. Inventory value allowance insufficient i.e. inventory is carried at higher value than net realisable value

c. Under provisioning of liability- the Company has been sued by former Director

d. IFRS 5- discontinued operations standard may not have been applied for the reduction in manufacturing & idling in factory resulting in carrying factory at higher value than fair value

e. Going concern may not be appropriate or under threat- the Company has single major contract which contributes 75% of revenue leading to over dependence.

2. Importance of audit planning-

ISA 315- Identifying and assessing the risks of material misstatement through understanding the entity and its environment, requires auditors ‘to identify and assess the risks of material misstatement, whether due to fraud or error, at the financial statement and assertion levels’. It is vitally important for auditors to assess engagement risks at the planning stage, this will ensure that attention is focused early on the areas most likely to cause material misstatements. A thorough risk assessment will also help the auditor to fully understand the entity, which is vital for an effective audit. Any unusual transactions or balances would also be identifi ed early, so that these could be addressed in a timely manner.

In addition, as most auditors adopt a risks based audit approach then these risks need to be assessed early in order for the audit strategy and detailed work programmes to be developed. Assessing risks early should also result in an efficient audit. The team will only focus their time and effort on key areas as opposed to balances or transactions that might be immaterial or unlikely to contain errors.

Further, assessing risk early should ensure that the most appropriate team is selected with more experienced staff allocated to higher risk audits and high risk balances. A thorough risk analysis should ultimately reduce the risk of an inappropriate audit opinion being given. The audit would have focused on the main risk areas and hence all material misstatements should have been identifi ed, resulting in the correct opinion being given.

It should enable the auditor to have a good understanding of the risks of fraud, money laundering, etc. Assessing risk should enable the auditor to assess whether the client is a going concern.

3. Following are 3 substantive procedures an auditor should perform-

i. Inventory count observation of high value items and random testing of other item from floor to inventory records and inventory records to floor for sufficient audit evidence regarding inventory record completeness.

ii. Inventory should be re-tested for net realisable value testing to assess appropriateness of inventory carrying value & allowances

iii. Obtain fair valuation report of factory and test the valuation assumptions, method and data

iv. Review financial statement for completeness of GAAP disclosure for IFRS 5.

v. Review assessment of use of going concern assumption and seek audit evidence.

Answer 3

Solution-I

Being a professional, First of all I define tthe meaning of Audit Risk

Audit Risk is the risk that an auditor expresses an inappropriate opinion on the financial statements. For Example:-

Issuing an unqualified report where a qualification is reasonably justified.

Failing to disclose a significant matter in the final audit report etc.

After consideration of above mentioned data of Apricot Company, following risk is identified:-

1. The company increse the credit period to 100 days from 28 days and reduce the price. Here my risk is related to the approval authority, who extend the such credit period and the amount of price reduction.

2. At which price products is imports from India, Whether these prices approved or not.

3. Whether Import price is less than Inhouse production or not.

4. What is the control over Goods-In-Transit and who is the responsible authority.

5. Whether company liable to pay the cost of Insurance of Goods-In-Transit.

6. At what basis Company assessed the scrap value of the redudant plant.

7. What is the probability of pay compansation to Finance Director (FD). Whether it should be shown in audit report as contingent liability.

8. What is authenticity of "continuous inventory counting system".

9. What is the basis of dividing the warehouses in 12 area.

Additionaly:- The Auditor (An Auditor in Juit Company) who conduct the Audit of IT & manufacturing organisation, may not have proper understanding of Operations of Apricot company. It is also a risk that associated with the audit. It can be mitigated through deep study of culture and operations of the company.

Solution-II

It is vitally important for auditors to assess engagement risks at the planning stage. Following is the importance of assessing risks at the planning stage of an audit.

1. This will ensure that attention is focused early on the areas most likely to cause material misstatements.

2. A thorough risk assessment will also help the auditor to fully understand the entity, which is vital for an effective audit.

3. Any unusual transactions or balances would also be identified early, so that these could be addressed in a timely manner.

4. In addition, as most auditors adopt a risks based audit approach then these risks need to be assessed early in order for the audit strategy and detailed work programmes to be developed.

5. Assessing risks early should also result in an efficient audit. The team will only focus their time and effort on key areas as opposed to balances or transactions that might be immaterial or unlikely to contain errors.
6. In addition assessing risk early should ensure that the most appropriate team is selected with more experienced staff allocated to higher risk audits and high risk balances

7. A thorough risk analysis should ultimately reduce the risk of an inappropriate audit opinion being given. The audit would have focused on the main risk areas and hence all material misstatements should have been identifi ed, resulting in the correct opinion being given.

8. It enable the auditor to have a good understanding of the risks of fraud, money laundering, etc.

Solution-III

I will perform the following Substantive procedures at the year-end in confirming

The valuation of inventory.

1. Identify the basis of dividing the Warehouses in 12 areas. Make physical counts of different items on test basis. If there are high value inventory, An auditor should spent extra time to such items.

2. Reconcile the inventory count to the general ledger:- They will trace the valuation compiled from the physical inventory count to the company's general ledger, to verify that the counted balance was carried forward into the company's accounting records.

3. Test inventory in transit:- Goods- In- Transit received after 3 months. Auditor should check this goods through reviewing transfer documentation, Letter of credit (If available), Bank Gurantee (If available) any other document available.

B. The completeness of provisions of contingent liabilities.

1. Auditor should assess the probablity of arising of such liability.

2. After completion of above step-1, Estimate the amount which can be paid to the Finance Director (FD). Such amount identified with discussion of company's advocate.

3. After completion of above steps, Auditor should give his final observation in final "Audit Report". Such amount should mention in the financial statement seperatly under footnote of "Contingent Liabilty".

.