PAA 4 – 2

51. Blue Window Glass Co (Blue) is a glass manufacturer, which operates from a large production facility, where it undertakes continuous production 24 hours a day, 7 days a week. Also on this site are two warehouses, where the company’s raw materials and finished goods are stored. Blue’s year end is 31 December.

Blue is finalizing the arrangements for the year-end inventory count, which is to be undertaken on 31 December 20X2. The finished windows are stored within 20 aisles of the first warehouse. The second warehouse is for large piles of raw materials, such as sand, used in the manufacture of glass. The following arrangements have been made for the inventory count. The warehouse manager will supervise the count as he is most familiar with the inventory. There will be ten teams of counters and each team will contain two members of staff, one from the finance and one from the manufacturing department. None of the warehouse staff, other than the manager, will be involved in the count.

Each team will count an aisle of finished goods by counting up and then down each aisle. As this process is systematic, it is not felt that the team will need to flag areas once counted. Once the team has finished counting an aisle, they will hand in their sheets and be given a set for another aisle of the warehouse. In addition to the above, to assist with the inventory counting, there will be two teams of counters from the internal audit department and they will perform inventory counts.

The count sheets are sequentially numbered, and the product codes and descriptions are printed on them but no quantities. If the counters identify any inventory which is not on their sheets, then they are to enter the item on a separate sheet, which is not numbered. Once all counting is complete, the sequence of the sheets is checked and any additional sheets are also handed in at this stage. All sheets are completed in ink.

Any damaged goods identified by the counters will be too heavy to move to a central location, hence they are to be left where they are but the counter is to make a note on the inventory sheets detailing the level of damage.

As Blue undertakes continuous production, there will continue to be movements of raw materials and finished goods in and out of the warehouse during the count. These will be kept to a minimum where possible.

The level of work in progress in the manufacturing plant is to be assessed by the warehouse manager. It is likely that this will be an immaterial balance. In addition, the raw materials quantities are to be approximated by measuring the height and width of the raw material piles. In the past this task has been undertaken by a specialist; however, the warehouse manager feels confident that he can perform this task.

You are the audit senior of Dial & Co and are responsible for the audit of inventory for Blue. You will be attending the year-end inventory count on 31 December 20X2. In addition, your manager wishes to utilise computer-assisted audit techniques for the first time for controls and substantive testing in auditing Blue Window Glass Co’s inventory.

Required:

(a) Describe the procedures to be undertaken by the auditor DURING the inventory count of Blue Window Glass Co in order to gain sufficient appropriate audit evidence.

52. Hut Pizzas Co (Hut) operates a large chain of fast food restaurants. You are an audit supervisor of Cheetah & Co and are currently preparing the audit programs for the audit of Hut’s financial statements for the year ended 31 March 2016. You are reviewing the notes of last week’s meeting between the audit manager and finance director where two material issues were discussed.

(i) Property, plant and equipment

In the past Hut has received negative press reports over the condition of its fast food restaurants, with comments suggesting, they are old fashioned and tired looking. Therefore, during the year, the company undertook a full review of all its assets and carried out extensive refurbishments to the majority of its restaurants. This review resulted in a significant amount of ageing fixtures and fittings being disposed of and a significant amount of capital expenditure was invested in all remaining restaurants.

(ii) Equity

The refurbishment was financed via a share issue in April 2015 at a premium of $1·6 million.

Required:

Describe substantive procedures you should perform to obtain sufficient and appropriate audit evidence in relation to the above two matters.

(i) Property, plant and equipment

(ii) Equity

53. It is 1 July 20X5 and you are an audit manager of Fish & Co and you are currently responsible for the audits of two existing clients:

Seafish Co manufactures hair products and its year ended on 31 May 20X5. You are finalizing the audit programs for the forthcoming year‐end audit.

John Co is a distributor of electronic goods and its year ended on 30 April 20X5. The audit is almost complete and the auditor’s report is due to be signed shortly.

The following matters have been brought to your attention for each company.

Seafish Co – Receivables

Seafish Co’s draft year‐end trade receivables are $3.85m (20X4: $2.45m) and revenue for the year is slightly increased on 20X4. Seafish Co has a large number of customers with balances ranging from $5,000 to $45,000. A positive receivables circularization has been undertaken based on the year‐end balances. The majority of responses from customers agreed to the balances as per Seafish Co’s receivables ledger, however, the following exceptions were noted:

Due to the increase in receivables, Seafish Co has recently recruited an additional credit controller to chase outstanding receivables. As a result of the additional focus on chasing outstanding receivables the finance director thinks it is not necessary to continue to maintain a significant allowance for receivables and has reduced the closing allowance from $125,000 to $5,000.

John Co – Going concern

During the year under audit John Co has consistently paid a number of its suppliers significantly later than usual and only after several reminders. As a result some of its suppliers have withdrawn credit terms meaning the company must pay cash on delivery. The company has also just received notification that its main supplier who provides the company with over 60% of its specialist electrical equipment has ceased to trade.

The overdraft has increased significantly over the year and the directors have informed you that the overdraft facility is due for renewal next month, and they are confident it will be renewed. The directors have decided that in order to conserve cash, no final dividend will be paid in 20X5.

Required:

(a) Describe the procedures the auditor should perform to resolve the exceptions noted for each customer during the positive receivables circularisation for Seafish Co.

(b) Describe substantive procedures the auditor should perform to obtain sufficient and appropriate audit evidence in relation to the allowance for receivables in the current year.

(c) Identify and explain THREE potential indicators that John Co is NOT a going concern.

(d) Describe the audit procedures the auditor should perform in assessing whether or not John Co is a going concern.

54. Airsoft Co is a listed company which manufactures stationery products. The company’s profit before tax for the year ended 31 December 20X6 is $16·3m and total assets as at that date are $66·8m. You are an audit supervisor of Biathlon & Co and you are currently finalising the audit programmes for the year-end audit of your existing client Airsoft Co. You attended a meeting with your audit manager where the following matters were discussed:

Trade payables and accruals

Airsoft Co purchases its raw materials from a large number of suppliers. The company’s policy is to close the purchase ledger just after the year end and the financial controller is responsible for identifying goods which were received pre year-end but for which no invoice has yet been received. An accrual is calculated for goods received but not yet invoiced (GRNI) and is included within trade payables and accruals. The audit strategy has identified a risk over the completeness of trade payables and accruals. The audit team will utilise computer assisted audit techniques (CAATs), in the form of audit software while auditing trade payables and accruals.

Bank overdraft and savings accounts

Airsoft Co’s draft financial statements include a bank overdraft of $2·6m, which relates to the company’s main current account. In addition, Airsoft Co maintains a number of savings accounts. The savings account balances are classified as cash and cash equivalents and are included in current assets. All accounts have been reconciled at the year-end.

Directors’ remuneration

Airsoft Co’s board is comprised of eight directors. Their overall remuneration consists of two elements: an annual salary, paid monthly; and a significant annual discretionary bonus, which is paid in a separate payment run on 20 December. All remuneration paid to directors is included within wages and salaries. Local legislation requires disclosure of the overall total of directors’ remuneration broken down by element and by director.

Required:

(a) Describe substantive procedures the auditor should perform to obtain sufficient and appropriate audit evidence in relation to the COMPLETENESS of Airsoft Co’s trade payables and accruals.

Excluding procedures included in part (a):

(b) Describe audit software procedures which could be carried out during the audit of Airsoft Co’s trade payables and accruals.

(c) Describe substantive procedures the auditor should perform to obtain sufficient and appropriate audit evidence in relation to Airsoft Co’s year-end bank balances.

(d) Describe substantive procedures the auditor should perform to confirm the directors’ remuneration included in the financial statements at the year-end.

55. Flash Co manufactures women’s clothing and its year end was 31 July 20X7. You are an audit supervisor of Fine & Co and the year end audit for Flash Co is due to commence shortly.

The draft financial statements recognise profit before tax of $2.6m and total assets of $18m. You have been given responsibility for auditing receivables, which is a material balance, and as part of the audit approach, a positive receivables circularisation is to be undertaken.

At the planning meeting, the finance director of Flash Co informed the audit engagement partner that the company was closing one of its smaller production sites and as a result, a number of employees would be made redundant. A redundancy provision of $110,000 is included in the draft financial statements.

Required:

(a) Describe the steps the auditor should perform in undertaking a positive receivables circularization for Flash Co.

(b) Describe substantive procedures, other than a receivables circularization, the auditor should perform to verify EACH of the following assertions in relation to Flash Co’s receivables:

(i) Accuracy, valuation and allocation;

(ii) Completeness; and

(iii) Rights and obligations

Note. The total marks will be split equally between each part.

(c) Describe substantive procedures the auditor should perform to confirm the redundancy provision at the year end.

56. Flower Co manufactures motor vehicle components and its year end was 30 June 20X8. You are an audit supervisor of Pepper & Co and the final audit is due to commence shortly.

Total assets are $43.2m and profit before tax is $7.2m. The following matters have been brought to your attention:

Trade receivables

Flower Co’s trade receivables ledger is comprised of a large number of customers. In previous years, the audit team has undertaken a positive trade receivables circularization to confirm year end balances. However, the customer response rate has historically been low and so alternative audit procedures have been undertaken. A decision has been made that for the current year audit a circularization will not be performed.

The year‐end trade receivables balance is $3.9m (20X7: $2.8m) and the allowance for trade receivables is $410,000 (20X7: $300,000).

Bank balances

The bank and cash figure included in Flower Co’s draft financial statements is comprised of a number of bank account balances: an overdraft of $5.1m which is the company’s main current account and $0.2m relating to several savings accounts. The finance director has informed the audit manager that all accounts have been reconciled as at the year end.

The overdraft of $5.1m has increased significantly since the prior year (20X7: $1.2m). The directors have informed you that the overdraft facility, which the company requires in order to operate on a daily basis, is due for renewal in October 20X8 and that they are confident it will be renewed.

Required:

(a) Describe substantive procedures the auditor should perform to obtain sufficient and appropriate audit evidence in relation to Flower Co’s trade receivables.

(b) Describe substantive procedures the auditor should perform to obtain sufficient and appropriate audit evidence in relation to Flower Co’s bank balances.

(c) Describe the audit procedures the auditor should perform in assessing whether or not Flower Co is a going concern.

57. Leaf Co operates a chain of health and fitness clubs. Its year end was 31 March 20X6. You are the audit manager and the year-end audit is due to commence shortly. The following three matters have been brought to your attention.

Trade payables and accruals

Leaf Co’s finance director has notified you that an error occurred in the closing of the purchase ledger at the year end. Rather than it closing on 1 April, it accidentally closed one week earlier on 25 March. All purchase invoices received between 25 March and the year-end have been posted to the 20X7 year-end purchase ledger.

Receivables

Leaf Co’s trade receivables have historically been low as most members pay monthly in advance. However, during the year a number of companies have taken up group memberships at Leaf and hence the receivables balance is now material. The audit senior has undertaken a receivables circularization for the balances at the year-end; however, there are a number who have not responded and a number of responses with differences.

Reorganization

The company recently announced its plans to reorganize its health and fitness clubs. This will involve closing some clubs for refurbishment, retraining some existing staff and disposing of some surplus assets. These plans were agreed at a board meeting in March and announced to their shareholders on 29 March. Leaf is proposing to make a reorganization provision in the financial statements.

Required

(a) Describe substantive procedures the auditor should perform to obtain sufficient and appropriate audit evidence in relation to the issues identified with the trade payables and accruals balance.

(b) Describe substantive procedures the auditor should perform to obtain sufficient appropriate evidence in relation to the year-end receivables balance.

(c) Describe substantive procedures the auditor should perform in relation to the proposed reorganization.

58. Mold Industries Co (Mold) develops and manufactures a wide range of fast moving consumer goods. The company’s year-end is 31 December 20X5 and the forecast profit before tax is $8.3 million. You are the audit manager of Neptune & Co and the year-end audit is due to commence in January. The following information has been gathered during the planning process.

Inventory count

Mold’s raw materials and finished goods inventory are stored in 12 warehouses across the country. Each of these warehouses is expected to contain material levels of inventory at the year end. It is expected that there will be no significant work in progress held at any of the sites. Each count will be supervised by a member of Mold’s internal audit department and the counts will all take place on 31 December, when all movements of goods in and out of the warehouses will cease.

Research and development

Mold spends over $2 million annually on developing new product lines. This year it incurred expenditure on five projects, all of which are at different stages of development. Once they meet the recognition criteria under IAS 38 Intangible Assets for development expenditure, Mold includes the costs incurred within intangible assets. Once production commences, the intangible assets are amortised on a straight line basis over five years.

Required:

Describe audit procedures you would perform during the audit of Mold Industries Co:

(i) BEFORE and DURING the inventory counts

(ii) In relation to research and development expenditure.

59. Corner deducts employment taxes from its employees’ wages on a monthly basis and pays these to the local taxation authorities in the following month. At the year end the financial statements will contain an accrual for income tax payable on employment income. You will be in charge of auditing this accrual.

Required:

(a) Describe the audit procedures required in respect of the year end accrual for tax payable on employment income

60. You are an audit manager of Berrycane & Co and you are currently responsible for the audit of Fruitso Co, a company which develops and manufactures health and beauty products and distributes these to wholesale customers. Its draft profit before tax is $6·4m and total assets are $37·2m for the financial year ended 31 January 20X8. The final audit is due to commence shortly, and the following matters have been brought to your attention:

Research and development

Fruitso Co spent $1·9m in the current year developing nine new health and beauty products, all of which are at different stages of development. Once they meet the recognition criteria under IAS® 38 Intangible Assets for development expenditure, Fruitso Co includes the costs incurred within intangible assets. Once production commences, the intangible assets are amortised on a straight line basis over three years. Management believes that this amortisation policy is a reasonable approximation of the assets’ useful lives, as in this industry there is constant demand for innovative new products.

Depreciation

Fruitso Co has a large portfolio of property, plant and equipment (PPE). In March 20X7, the company carried out a full review of all its PPE and updated the useful lives, residual values, depreciation rates and methods for many categories of asset. The finance director felt the changes were necessary to better reflect the use of the assets. This resulted in the depreciation charge of some assets changing significantly for this year.

Bonus

The company’s board is comprised of seven directors. They are each entitled to a bonus based on the draft year-end net assets, excluding intangible assets. Details of the bonus entitlement are included in the directors’ service contracts. The bonus, which related to the 20X8 year end, was paid to each director in February 20X8 and the costs were accrued and recognised within wages and salaries for the year ended 31 January 20X8. Separate disclosure of the bonus, by director, is required by local legislation.

Required:

(a) Describe substantive procedures the auditor should perform to obtain sufficient and appropriate audit evidence in relation to Fruitso Co’s research and development expenditure.

(b) Describe substantive procedures the auditor should perform to obtain sufficient and appropriate audit evidence in relation to the matters identified regarding depreciation of property, plant and equipment.

(c) Describe substantive procedures the auditor should perform to obtain sufficient and appropriate audit evidence in relation to the directors’ bonuses.