What other risk factors (aside from those related to receivables and inventory) do you think will impact on the audit?


 Assignment 2

Value: 20%

Length: 2500 words

Question 1 Inherent Risk, Control
Risk and Audit planning (6% of total subject assessment)

You are the audit senior responsible for the audit of Delilah Ltd. You are
currently planning the audit for the year ended 30 June 2012. During your
initial planning meeting held with the financial controller, he told you of the
following changes in the companys operations:

(i) Due to the financial
controllers workload, the company has employed a treasurer. The financial
controller is excited about the appointment because in the two months that the
treasurer has been with the company he has realized a small profit for the
company through foreign-exchange transactions in yen.

(ii) Delilah has planned to close an
inefficient factory in country New South Wales before the end of 2012. It is
expected that the redeployment and disposal of the factorys assets will not be
completed until the end of the following year. However, the financial
controller is confident that he will be able to determine reasonably accurate
closure provisions.

(iii) To help achieve the budgeted
sales for the year, Delilah is about to introduce bonuses for its sales staff.
The bonuses will be an increasing percentage of the gross sales made, by each
salesperson, above certain monthly targets.

(iv) The company is using a new
general ledger software package. The financial controller is impressed with the
new system, because management accounts are easily produced and allow detailed
comparisons with budgets and prior-period figures across product lines and
geographical areas. The conversion to the new system occurred with a minimum of
fuss. As it is a popular computer package, it required only minor

(v) As part of the conversion, the
position of systems administrator was created. This position is responsible for
all systems maintenance, including data backups and modifications. These tasks
were the responsibility of the accountant.

(vi) The managing director has
returned from the USA, where he signed a contract to import a line of clothing
that has become the latest fashion fad in the USA. The company has not
previously been engaged in the clothing industry.


For each of the scenarios above,
identify which of the components of audit risk (inherent, control or detection
risk) are affected. In your answer you will need to justify you choice. Format
your answer as follows:

Inherent Risk or





Marking criteria

Marks will be awarded for responses
to question 1based on the extent to which you:

Identify the component of audit risk affected
Justify your selection of the
relevant component of audit risk

Question 2 Internal Controls
and Substantive Testing (6% of total subject assessment)

You are the auditor of PC Ltd., a
company that produces low cost electronic goods to children and young adults.
The audit has a year end of 30th June 2012.

There are four main people involved
with the acquisitions of inventory for PC Ltd. Ms Auburn is the purchases
officer; Mr Brown is the Accounts Payable Clerk; Mr Crimson is the
Financial Controller and Ms Dark is the Payments Officer.

The acquisitions system works as

· Ms Auburn is responsible for
purchases within PC ltd. There is a computerized inventory system and whenever
the inventory level goes below a certain level, Ms Auburn prepares a purchases
requisition to buy new stock from one of three suppliers that PC uses.

· Ms Auburn then prepares a three
part prenumbered purchase order. Every Month Mr Crimson reviews a listing of purchase
orders issued to ensure all have been accounted for. The original copy of the
purchase order is sent to the vendor. The receiving department within PC is
sent the second copy, which is then used as a receiving report. The third and
final copy is kept on file within the purchases department along with the
original purchases requisition.

· When the purchased goods arrive
they are immediately sent to the receiving department where the receiving
report (which is the second copy of the invoice) is filled out by the
store-room employee and authorized by the store-room supervisor. A copy of this
document is taken and kept in the store-room. The original is sent to Mr Brown
in accounts payable.

· When the supplier invoice is
received it is forwarded to Mr Brown. He checks the price on the invoice
compares the quantities to the details on the receiving report and checks the
footings and calculations. Once this is done he enters the details of each
invoice into the computer system that updates the purchases journal and
accounts payable master file.

· The invoice is then sent to Mr
Crimson for authorisation. Attached to the invoice is a copy of the materials
purchase requisition and the receiving report. After Mr Crimson has approved
the invoice for payment the documents are sent to the person responsible for
cheque preparation in the accounting department (Ms Dark).


a) Identify three controls that
operate within this system and state the potential errors they are aimed at

b) Describe two additional controls
(or improvements to controls) that you would implement into this system and

c) Describe the substantive tests
that you would perform on transactions in the acquisitions cycle of this system
to gain adequate assurance over the assertions of completeness, cut off and

Marking criteria

Marks will be awarded for responses
to question 2based on the extent to which you:

Identify the relevant internal controls and the errors they are aimed at preventing.

Describe two additional controls or improvements to the existing controls that
you would implement and why.

Describe the audit procedures you would perform in relation to the assertions
identified in the question.

Question 3 Analytical
procedures and Substantive Testing (8% of total subject assessment)

Below are the financial statements
and additional information for Tehran Ltd.

Balance Sheet

Current Assets
Total Current Assets82616048
Non Current Assets
Property Plant & Equipment2876329417
Total Non Current Assets3076331417
Total Assets3902437465
Current Liabilities
Bank Loan Secured50007500
Accounts Payable25002473
Total Current Liabilities814310583
Non Current Liabilities
Bank Loan Secured2200020000
Total Non Current Liabilities2254720510
Total Liabilities3069031093
Net Assets83346372
Shareholders Equity
Share Capital50005000
Retained Profits33341372
Total Shareholders Equity83346372
Income Statement
Gross Profit67024515
Operating Expenses34863047
Net Profit Before Tax32161468
Net Profit After Tax1962896
Retained Profits: Beginning1372476
Retained Profits: End33341372

Tehran Ltd manufactures carpets.
Approximately 80% of the companys sales arise as a result of exports. When
Tehran sells abroad the customers are billed in the currency of that country.

The main raw material used by Tehran
is wool, which is purchased locally in Australia. You have been informed that
the companys profitability has improved due to a recent slump in wool prices.

With the exception of the managing
director, Hank Largow, all of the management of Tehran are from Australia. Hank
is on a five year contract which was put in place by Tehrans US parent
company. Hank has a reputation for delivering results from subsidiaries which
have not performed well in the past. Hank does not much like Australia and has
every intention of returning to the US when his contract is finished. The US
parent company was dissatisfied with the companys 2011 performance and has
paid close attention to the companys performance in 2012.

The company operates a standard
costing system and the finished goods inventory is valued at standard cost. Raw
materials are valued at actual invoiced cost. No work in progress exists at
year end. During 2012, production has been increased by 10% compared to 2011
levels. His has resulted in favourable absorption variances which have contributed
to the improved profitability during 2012.

Tests on the compnays inventory and
debtors controls in prior years have shown the systems to be reliable. The
systems are capable of producing reports on the ageing of inventory and debtors
and the sales history of individual profit lines.

Approximately 80% of the companys
receivables are overseas customers and the debt is denominated in foreign
currency. Most of these customers are on 60 day credit terms.

Midway through the year a new
financial controller, Mr Pink, was appointed after the previous financial
controller resigned. Mr Pink has informed you that a number of customers have
complained about the quality of Tehrans products.

The property plant and equipment
account is broken down as follows:

Property factory

Plant & Equipment (including


Additions and disposals of fixed
assets have not been substantial during 2012. The factory itself was acquired 6
years ago and since that time no independent valuation has been carried out.
Hank has assured you that the current market value of the company is not less
than $27,000,000.

The bank loans are secured by a
fixed charge over the companys buildings. A loan repayment of $5 million due
on 30th November 2012 was reduced to $500,000. Hank has stated that
this was done with the agreement of the bank and that the bank is comfortable
with the companys performance. Hank also pointed out that the company has made
all of its interest payments on time.

The non-current receivable is an
export market development grant from the federal government.

In prior years no serious
differences between the auditors and the management have arisen. The audit has
always been completed on time with an unqualified opinion issued.


Calculate the following
ratios: Gross Margin, Net Profit Ratio, Return on total assets, Current Ratio,
Quick Ratio, Inventory Turnover, Accounts Receivable turnover, Debt to Equity
Ratio (NB, for inventory turnover and accounts receivable turnover, assume the
balances for 2010 are the same as 2011).

Making reference to the ratios you calculated in part a) and the additional
information provided, describe what you consider to be the risk factors that
will impact on the audit of receivables and inventory.

What other risk factors (aside from those related to receivables and inventory)
do you think will impact on the audit?

In respect to the accounts of Inventory, Accounts Receivable and Land and
Buildings, outline the substantive procedures you would perform. (In your
answer you will need to identify the audit assertion(s) most at risk for each
of these


This assignment has been designed to
assess your ability to:

Understand the knowledge required by an auditor in preparing an audit strategy
and audit plan.
2. Outline the types of and uses for analytical

Explain how the auditor undertakes an assessment of control risk and how this
assessment impacts upon audit procedures.

Undertake substantive tests of balances and substantive tests of transactions
on key cycles with reference to the financial report assertions.

Marking criteria

Marks will be awarded for responses
to question 3based on the extent to which you:

Correctly calculate all ratios

Effectively and consistently apply the results from those ratios calculations
to identify account areas at risk.

Outline the audit procedures and related assertions used to address the risks
identified in part b).

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